Series 7 Study Guide
Post 1 of 14
- 1.1 Contact with potential and current customers
- 1.2 Describing investment products to customers
- 2.1 Tells potential customers about the account types
- 2.2 Secures and updates information about customers
- 2.3 Gather customer investment profile information
- 2.4 Get necessary supervisory approval to open accounts
- 3.1 Passing on all investment strategy information to customers
- 3.2 Analyze customer's portfolio of investments
- 3.3 Disclose to clients characteristics and risks of investment products
- 3.4 Communications with customers
- 4.1 Providing current quotes for investors
- 4.2 Processing and confirming customer transactions
- 4.3 Notifies the correct supervisor, helps with solving issues
- 4.4 Dealing with margin issues
Post 1 of 14 in the Series 7 Study Guide
In-person, telephonic, mail, and electronic contact with potential and current customers; marketing and advertising material development and the approval to distribute them.
There are two major reasons why broker-dealers need to communicate effectively with the public.
The first reason is that advertising – a critical form of communication for all businesses – pays.
How can you find potential clients otherwise?
That’s why advertising has been around for decades and has become a finely honed tool in finding potential clients and turning them into paying ones.
And that’s the second reason why broker-dealers need effective communication because once you’ve turned them into paying customers, excellent communication is one of the tools that can help keep them on your books.
Of course, FINRA regulations, specifically Rule 2210 cover everything to do with communication and advertising for broker-dealers.
Types of public communication
For the most part, the main aim of FINRA’s regulations is to ensure that all communication and advertising is never deceptive or manipulative and that it never makes use of fraudulent claims or devices.
Part of the regulations divides communication into various categories.
Now, this is covered in the SIE exam, for example, but for the Series 7 prep, let’s go a little more in-depth into these types of communications made to retail investors.
Before we jump into them, let’s just clarify exactly what a retail investor is.
They are any individual, both those who don’t have an account with the firm as well as those who might.
Retail investors are not institutional investors/clients, however.
Correspondence describes any electronic or written communication made to 25 or fewer retail investors over a 30 calendar-day period.
As per FINRA’s regulations, this will include both prospective and current clients.
When it comes to both incoming and outgoing correspondence, each member firm is required to draw up written procedures.
These must relate to what the company does, how big it is, and how it is structured.
This will be different for the various players we find in the world of securities.
These procedures should also cover:
- Reviewing incoming correspondence and directing it to the relevant registered representative
- Handling customer complaints from various sources but particularly those linked to customer funds/securities
- Principals carrying out either pre or post review of correspondence
Should pre-reviews not be required, the person(s) handling incoming correspondence must be trained as to the procedures regarding them.
FINRA may from time to time check that all of the above has been carried out by a member firm.
Retail communication describes any electronic or written communication made to 25 or more retail investors over a 30 calendar-day period.
Various sales literature as well as advertisements, for example, are covered under this form of communication.
Here are a few examples:
- Sales scripts or telemarketing
- Social media updates or any other electronic posts that reach more than 25 retail investors
- Radio or television advertising storyboards
- Reprints that have been prepared independently.
All retail communication must be approved by a qualified registered principal of the company.
There are some exceptions to this, however, specifically if:
- FINRA’s advertising department has approved the retail communication for another member firm already
- It has not been altered in any way following FINRA’s approval
- If it will be posted to an electronic forum
Should a communication not make a financial/investment recommendation or promote a product or service, then, in most cases, it won’t require principal approval before it is used.
Retail communication must be kept for three years from the last time it was used.
While the other forms of communication cover retail investors and other potential clients, institutional communication is only written communication made to institutional investors.
This does not include internal communication within the company, however.
Here’s what FINRA describes as institutional investors:
- FINRA member firms
- Registered person belonging to a FINRA member firm
- Banks and savings and loan institutions
- Insurance companies
- Registered investment companies
- Registered investment advisers
- An entity (including a natural person) with assets of $50 million or more
- Government entities
- 401(k), 403(b), 457, and other employee benefit plans that include 100 or more participants (not the individuals, however)
- Someone acting on behalf of an institutional investor
Remember, if someone doesn’t fall under the institutional investor category, they are immediately a retail investor.
If institutional communication is shared with someone who is not an institutional investor (in some manner), it must be treated as retail communication.
This carries on until it can be concluded that the sharing of this information has come to an end, for example, the social media post sharing it was deleted.
When it comes to institutional communication, each member firm is required to draw up written procedures as to how it is handled.
These must relate to what the company does, how big it is, how it is structured, and its customers.
These procedures help to ensure that institutional communication is reviewed, is of an applicable standard, and complies with FINRA regulations before it is sent out.
Should pre-reviews not be required, the person(s) handling institutional communication must be trained as to the procedures regarding them.
Follow-ups should also be carried out regularly to see that these procedures are adhered to.
FINRA may from time to time check that all of these have been implemented, carried out, and regularly maintained.
There are other forms of communication that should be noted.
- Public appearance
- Independently prepared reprint
- Research reports
When a registered representative takes part in a seminar, for example, this is considered to be a public appearance.
And yes, it is a form of communication.
Other types of public appearances include participating in a radio or television interview, being a guest on a webinar, and more.
There is one proviso when it comes to public communication.
It must be unscripted.
In this way, it will not be classified as correspondence, retail, or institutional communication.
Much like the others we’ve already covered, there needs to be written procedures and education/training in place that supervise the public appearances made by associated persons.
Also, in some firms, preapproval of an appearance may be necessary from the principal while FINRA may check that these procedures are implemented.
Remember, it’s not just what the registered representative says during a public appearance that counts as communication.
If they hand out material, have a presentation, or make a speech, that’s communication too and should be treated as such as it falls within the regulations we’ve already outlined.
For example, if it will be conveyed to more than 25 people over 30 days, it’s considered as retail communication.
And in that case, it should always be preapproved by a principal.
Lastly, don’t forget these:
- If a security or product is recommended during a public appearance, there must be a reasonable basis for that recommendation
- All conflicts of interest regarding the security/product (if any) must be disclosed but not if it is an insurance variable contract or a mutual fund
- If showing the performance of a mutual fund or variable contract, only the last 12 months is allowed
Independently prepared reprint (IPR)
An IPR is a reprint of an article where certain standards are met.
Most importantly, an independent publisher prepared the reprint and that the material is not changed in any way by the firm using it.
The only content changes that can be made are to correct any errors or to make them apply to regulatory standards.
Reprinting articles that have been used before is considered an IPR if it meets certain conditions:
- The publisher is not affiliated with the member company
- The publisher is not in any way connected to the security mentioned in the reprint, for example, the issuer or an underwriter
Neither the member using the reprint, the issuer of the security nor the underwriter are allowed to have commissioned the reprint.
Finally, as per FINRA regulations, all IPRs must receive preapproval from a principal.
FINRA filing requirements don’t apply to them either.
A strategist/analyst (who is part of a research team) prepares research reports for broker-dealers and investment advisers.
The report usually will highlight a particular stock or perhaps a certain part of the economy and is usually used as a way to help show how holding, buying, or selling an investment will be an advantage to a current or potential investor.
FINRA regulations help to ensure that these reports are objective while providing the necessary information that’s both reliable and useful in helping them make investment decisions.
Due diligence must be undertaken by all member firms to ensure research reports offer an honest view.
They should never be influenced by conflicts of interest either.
It’s a fraudulent action for a member to issue a report that includes opinions that are not consistent with the analyst’s actual views.
For the investing public to receive objective information from a research report, FINRA requires the following:
- The rating system used by firms must be explained clearly. This means using simple meanings for rating terms, highlighting the percentage of ratings for each category assigned, and showing the percentage of each category’s investment banking clients.
- The firm’s investment banking revenues and the compensation for the analyst cannot be tied
- If they or their household has a financial interest in a security promoted, analysts must disclose this during public appearances or in the research reports they contribute to. They must also disclose if their employer owns over 1% of the company’s equity securities.
- Research reports must reveal if the firm has been paid investment bank services fees related to another company’s public offering – the subject of that report. It must also reveal if the firm has managed or co-managed that public offering.
- Research reports may not be presented by investment advisers without them disclosing that it was not prepared by them. If they have done that, they still can base their recommendations on the content within the report.
When it comes to research reports, we must mention the quiet period.
For 40 days following an initial public offering (IPO) of a security offering, an acting manager or co-manager member firm’s analyst cannot make a public appearance nor can research be published about the subject company.
This rule also pertains to an additional issue offering, but the time frame is now 10 days.
Remember, the date of the offering according to FINRA would be either the date on which the securities were offered to the public or the later of the effective dates found on the registration statement.
Lastly, these items are not included in the definition of research reports.
- Broad-based indices discussions
- Economic, political, or market condition commentary
- Technical analysis related to sector supply and demand, industry trade, volume, and price or indexes.
- Summaries of the financial data of multiple companies statistically (including current rating listings)
- Price target change or notice of ratings
Thanks to the growth of the world wide web, electronic communication has become crucial over the last two decades.
Of course, FINRA quickly provided rules and regulations regarding this form of communication which probably is now the preferred method in the securities industry.
For example, a firm’s website is considered as retail communication and therefore must adhere to the record-keeping and filing rules as set out by FINRA.
Nowhere on a website can a business affiliation with or FINRA approval appear either.
That’s just misleading and against the rules.
The firm can indicate that they are a member of FINRA, however.
While electronic bulletin boards and a chat room are considered to be retail communication, if a representative uses one, they need not identify themselves as registered.
An interactive online forum, however, does need the approval of the principal if a registered representative is to use it.
That approval need not be for every post made, however.
As for emails to customers, well these are considered as correspondence and subject to the regulations that govern them.
Depending on the size of the audience receiving them, text messages can either be correspondence or retail communication.
SEC Advertising rules
Let’s look at two SEC rules that you should know about as you prepare for the exam:
- Rule 135a which pertains to generic advertising
- Rule 156 which deals with company sales literature
Rule 135 – Generic advertising
What is generic advertising?
Well, while it doesn’t promote a specific security, it does promote them as a medium for investment.
This form of advertising will provide information about:
- Securities investments on offer from a firm
- Investment companies and how they operate
- The services offered by the firm with regards to specific securities
- Information about the types of investment companies in the securities world
- Reinvestment privileges and exchange descriptions
- Contact details for those members of the public who want to find out more
The sponsor of any generic advertising must include their name and address on the advertising.
It cannot include the name of specific securities, however, while the firm placing the advertising must offer the service or security described therein.
Rule 156 – Investment Company Sales Literature
Federal law prescribes that any sales literature in connection with offers or sales of securities used by a company or a registered representative thereof may not in any way be misleading.
It is considered to be misleading if:
- There are untrue statements passed as material fact within it
- Doesn’t include a material fact that enforces the statement made is not misleading
More often than not, performance reporting of securities is where most of the misleading information is provided.
Rule 156 describes these as:
- Based on past investment performance, representatives insinuate that future performance could be similar
- Not disclosing certain nonrecurring fees, for example, a sale load as well as not disclosing what the fee is
Investment company sales literature that includes performance data and the average annual total return for one, five, and 10-year periods must be included.
This relates to the average annual total return after taxes on distributions and redemptions.
If funds are new (less than five years), data should be shown for every year.
For funds that have been around for decades, this data can be shown in five-year increments.
This is not applied to a money market fund, however.
Rule 156 also covers naming conventions for investment companies.
For example, should a company call itself Bob’s Bond Fund, 80% of its assets have to be invested in bonds as the name suggests under Rule 156.
Communication: Review, approval, and filing
Here’s a recap of the requirements when it comes to the review or approval by the principal of a firm:
- Institutional: Preapproval from the principal is not required
- Retail: Before use, the principal’s preapproval is necessary
- Correspondence: Can be reviewed before or after use by the company principal
- Public appearance: Principal preapproval although not mandated, may be required in certain situations
- Independently prepared reprints: If the communication is considered as retail communication, then preapproval from the principal is a must
- Research reports: Depending on how they are defined preapproval is necessary for those considered as retail.
- Electronic communication: For a website, preapproval will be needed as is the use of electronic bulletin boards (but not every post). When it comes to instant messaging, if messages are considered to be retail, they must be approved beforehand. Any general advertising needs principal preapproval as well.
For new members of FINRA, any retail communication sent out must be filed with the regulator at least 10 days before it is used in a process known as prefiling.
This includes retail communication in the following media:
- Public and electronic media (including websites)
- Periodicals and magazines
- Audio and telephone recordings
- Radio and television
- Billboards, signs, and video displays
- Routine listings and telephone directories
Following the first year, firms now can file retail communication with FINRA 10 days AFTER they first use it.
This is called postfiling.
Let’s start this section by looking at product-specific advertising and disclosures made by investment firms.
Product-specific advertising and disclosures
As we’ve mentioned, all public communication from a FINRA member firm is expected to be carried out based on good faith and fair dealing.
Nothing should be left out that can cause the particular communication to mislead potential investors.
To help determine if it is or not, FINRA says that the following should always be considered:
- The entire context of the statement. In one context, a statement can be misleading but in another, it may be appropriate. To aid in this regard, see that the statement provides balanced treatment when it comes to risks and potential returns.
- Depending on the audience the communication is aimed at, different details and levels of explanation might be necessary. Also bear in mind how the communication will be controlled to help with who comes into contact with it.
- Statement clarity is essential as those that are unclear just lead to misunderstandings. This could constitute a FINRA rule violation.
Investment company rankings
Investment company rankings cannot be used by member firms in retail communications unless:
- A ranking entity has created and published the rankings
- An investment company or an affiliate of one has created the rankings based on standard performance measures
When it comes to the required disclosures of investment company rankings, headlines or statements cannot imply or say that the investment company or the group of companies they belong to perform best in their investment category unless they are ranked first by ranking entities.
Other disclosures that are required include:
- The category name
- The ranking entity that’s carried out the ranking
- The ranking criteria used
- The fact that future results aren’t guaranteed by past performances
- Rankings showing total return must include rankings for one, five, and 10 years or since inception, if the firm is new
Backed by a pool of mortgages, CMOs are multi-class debt instruments.
Compared to stocks and bonds, they are much more complex.
Before a member can sell CMOs to retail customers they must be trained and provide educational materials that include:
- Risks of CMOs
- Characteristics of CMOs (average lives and prepayment rates)
- The effect of interest rates on prepayment rates and value
- Liquidity and transaction costs
- CMO structure (tranches offered and their risks)
- Mortgage loans and mortgage securities and the relationship between them
- Investor questions
CMO retail communication:
- Cannot compare other investment types against CMOs, for example, bank CDs.
- Must say that government agency backing is not to premiums paid but to the CMOs face value (where applicable)
- Show that the yield and average life of the CMO fluctuates based on interest rate changes and prepayment rates
It’s important to note the three main forms of communication that we’ve spoken about are also applied to options.
So that means, when it comes to retail communication relating to them, it’s going to have to be given the go-ahead by a registered options principal, also knowns as an ROP.
With retail communications for options, should the OCC Disclosure Booklet (ODD) not have been delivered, copies of the communication must be provided to FINRA 10 days before prefiling (or first use).
This can be done in two ways, either by sending a hard copy or electronically.
Note that FINRA limits option advertising to:
- A description of the issuer, the Options Clearing Corporation (OCC), and the security on offer
- A description of how the options market functions and the nature of it
- Who placed the advertisement (member firm, name of person to contact, and address/contact details). This is where interested parties can obtain an OCC Disclosure Booklet.
As long as they don’t mislead, advertising can include various advertising designs and devices.
Options advertising may not include past or projected performances or any recommendations.
While we’ve covered some of FINRA’s rules when it comes to filing of advertising, for example, approval from a principal, there are others still to add that are important.
Filing communications with FINRA 10 days before first use is a necessity.
- All communications for a new FINRA-member firm in their first year
- Retail communication that comprises custom rankings for registered investment companies
- Retail communication about options where the ODD has not been sent to FINRA before. For this, it must be sent 10 calendar days in advance.
This takes place 10 business days before the first use date and includes retail communication:
- That recommends or promotes investment companies and others linked to them
- About public DDPs
- About registered CMOs
For radio and television advertising, while the storyboard has to be filed to obtain FINRA’s approval, the final version also must be sent to them.
This must occur within 10 days of first use.
Filing requirement exclusions
Some retail communication won’t have to be filed, for example:
- If it has been sent to FINRA before and hasn’t changed but will be used again
- If it doesn’t promote a product/service or make investment/financial recommendations
- If it identifies a security that the member is a registered market maker for
- If it doesn’t identify the member
- If it is correspondence
- If it is institutional communication
- If it shows investment types in a product/services listing that the member offers
- If posted online in an electronic forum
Variable contracts communication
Other than the general FINRA regulations governing communication, for variable contracts, there are more standards that need to be applied.
Applicable to sales literature, advertising, and individualized communication, they include:
- Product communication
- And more
With product communication, where applicable, communications must describe it as either a variable life insurance or variable annuity.
No implication maybe be made that the product or the underlying account associated with it is a mutual fund.
Also, other than the descriptions of the produced, proprietary names can be used.
When it comes to liquidity, communication must never imply that variable annuities or life insurance are liquid, short-term investments.
That’s because although withdrawals can be made, that incurs massive charges and has tax penalties too.
Any communication that covers the products mentioned above must include the negative factors that early withdrawal has, including tax penalties, a decline in cash value, and an impact on death benefits.
Insurance products have guarantees attached to them.
Communication, however, may not overemphasize these guarantees, especially in terms of the safety of the product relating to them.
Guarantees cannot be linked to the investment returns either or the financial ratings of the insurance company apply to the separate account.
Single premium variable life
A proper explanation of the life insurance features of a single premium variable life product must be included if communication highlights the investment features it offers.
Illustrations showing potential rates of return for variable life insurance products
These can be used to show potential rates of return but there are rules that govern these illustrations:
- They cannot be used to predict/project investment results
- They can include gross rates of up to 12% with any combination of assumed investment returns. One of the returns, however, must be 0%. As for the maximum rate shown, this must consider all investment options, take market conditions into account, and should always be reasonable
- For each assumed rate of return, they must show expense charges and maximum mortality.
Normally, these products should not be gauged against other investment products.
Comparisons between these products and term insurance products are allowed as long as it shows the idea of tax-deferred growth as a result of variable product investment.