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Flashcards in Unit 1 - Chapter 1 - Securities Regs Deck (64):
1

Under the the Investment Company Act of 1940 name the three categories of investment companies.

1.) Face Amount Certificate Company - kind of registered investment company
2.) Unit Investment Trust - registered investment companies - package of debt or equity securities that does have a management company. Units are redeemable and no management
3.) Management Companies

2

Under the Investment Company Act of 1940, what are the two kinds of management companies?

1.) open-end: typically mutual funds
2.) closed-end

3

What is the difference between an open-end and closed-end management company?

Open-end is continuously issuing new shares. Closed-end is closed to new people once shares are sold

4

Under the Investment Company Act of 1940, what are the requirements for investment company registration with the SEC?

1.) Have private capitalization of at least $100,000
2.) Cleary defined investment objective (I.e. growth, income, speculative, etc.)
3.) Must file annual reports to SEC
4.) file semi-annual reports to shareholders

5

What are the shareholder rights under the Investment Company Act of 1940?

1.) Changing the nature of the business - shareholders can vote to change the business from investment company
2.) Changing the investment objective or policy (Internet fund example)
3.) Changing the investment advisor or manager

6

What is the structure of investment companies under the Investment Company Act of 1940?

1.) Board of Directors - can’t have a felony or misdemeanor
2.) 40% of the Board have to be “non-interested directors” (have no other role with the fund)
3.) Investment Advisor to manage portfolio for a fee
A.) initial investment advisor contract is 2 years, renewable annually
B.) maximum of 60 days of termination
C.) contract must be in writing between money manager and the fund

7

What are the general restrictions on investment company management, according to the Investment Company Act of 1940?

1.) Can’t purchase securities on margin - exceptions are hedge funds
2.) Can’t selling short - must be done through a margin account
3.) Can’t do speculative options (can’t do naked calls)
4.) Can’t have a joint trading account
5.) Can’t purchase more than 3% of the voting shares of another investment company

8

Explain 12b-1 fees.

Under 12b-1 investment companies can charge fees for sales and promotional expenses. Ongoing fee the investment company will take take as a % of investment.

9

How are 12b-1 fees approved by investment companies?

1.) Initial approval: Whole board, independent board and shareholders
2.) Annual renewal and quarterly review: Whole board and independent
3.) Termination: Independent board or the shareholders
*Note: Nothing can go on with the 12b-1 fee w/o approval of the independent board.
4.) If the load wants to be a “no-load” fund the 12b-1 fee can not be higher than 25 bps, if higher the fund can’t sell as a “non-load” fund

10

What is the definition of the insider trading according the Insider Trading and Securities Fraud Enforcement Act of 1988?

Using information not available to the public to profit or avoid a loss.

11

What are the civil penalties for being found guilty of the Insider Trading and Securities Fraud Enforcement Act of 1988?

Up to the greater of $1 million or 300% of profit made or loss avoided. 300% aka “trembled damages”

I.e. made $2,000,000 +3x = $6,000,000 fine plus the $2,000,000 made

12

What is the criminal penalty under the Insider Trading and Securities Fraud Enforcement Act of 1988?

Jail term of as much as 20 years

13

Explain how the tippper and tippee are liability may be liability Insider Trading and Securities Fraud Enforcement Act of 1988.

Just know that this is a possibility.

14

Explain the misappropriation theory of the Insider Trading and Securities Fraud Enforcement Act of 1988.

Insiders who violate insider trading rules may be liable to contemporaneous traders who did not have insider information for losses sustained

The buyers of securities that were traded with insider knowledge can bring private litigation against that person. Have 5 years to institute the suit. Damages are profits the other person made or loss the insider avoided. NO PUNITIVE OR TREBLE DAMAGES

15

What is the NSMIA?

National Securities Markets Improvement Act of 1996

16

Name the groups and organizations that must register with the SEC?

1.) Brokers and Dealers
2.) Securities Exchanges
3.) Nationals Securities Associations - FINRA & the MSRB (Maloney Act of 1938)
4.) Corporations with listed securities
5.) Securities Information Processors (SIPs)
6.) Transfer Agents

17

Explain the Insider Transactions under the Securities Exchange Act of 1934.

Regulates securities transactions by insiders who generally own large amount of their companies' stock.

18

Who must file a statement with SEC concerning the amount of equity securities owned, according to the Insider Transactions under the Securities Exchange Act of 1934?

1.) Every person who is directly or indirectly the beneficial owner of more than 10% of any class of equity securities registered on a national securities exchange
2.) officers or directors of the issuers of such securities

19

What is a Schedule 13(d) Filing?

5% Beneficial Owners - requires beneficial owner of more than 5% of the a class of equity securities to register under the Sec Exchange Act of 1934 (meaning publicly traded companies) to file a report with the issuer, SEC, and the securities markets where those securities trade within 10 days of any transaction that results in beneficial ownership of more than 5%.

20

What are the reporting requirements of Schedule 13(d)?

1.) Name and background of the person or entity
2.) origin of the money for the acquisition
3.) purpose of acquiring the securities

21

What is a Section 13(f) filing?

Requires that any institutional investment manager that uses the mail or any means of instrumentality of interstate commerce in the course of its business as a institutional money manager, and that exercises investment discretion over an equity portfolio with a market value on the last trading day in any of the preceding 12 months of $100 MM or more must file Form 13F with the SEC quarterly, within 45 fays of the end of each quarter

22

What are 13(f) Securities?

Exchange-traded or Nasdaq quoted stocks, equity options, warrants, shares of closed-end investment companies, certain convertible debt securities, ETFs

23

What is a schedule G filing?

A passive investor whose beneficial ownership exceeds 5% of any registered security. Passive investors must file within 10 calendar days after crossing the 5% threshold and must amend their Schedule G within 45 days after the end of the calendar year.

24

What is a passive investor?

Any person who certify that they did not purchase or do not hold the securities for the purpose of changing or influencing control over the issuer and hold no more than 20% of the issuer's securities. I.e. investment companies and large pension funds

25

What is a Section 16(a) filing?

Requires executive officers, directors and great than 10% stockholders (i.e., control persons) to file a transaction reports before the end of the second business day following the day on which a transaction has been executed in any equity security where they are consider an insider.

26

How much are the margin requirements that can be extended to customers?

50%

27

Why are mutual funds not purchased on margin?

Underwriters must receive full payment for new issues within 35 days of purchase. Mutual funds are a considered a continuous new issue, therefore their shares my not be purchased on margin. Once the share have been owned in the account for 30 days, they may be used as collateral for a margin loan.

28

Explain Churning?

a B/D effecting transactions in a discretionary account that are excessive in size or frequency, in view of the financial resources, objectives, and character of the account

29

Explain wash trades?

a prohibited action that involves a securities transaction that involves no change in the beneficial ownership of the security. i.e. a B/D buying the security from one B/D firm but selling the shares at another B/D firm to create the appearance of substantial trading activity, which is misleading to investors

30

Explain matched orders?

An illegal act that involves entering of a sell or buy order knowing that a corresponding sell or buy order of substantially the same size, at substantially the same time and at substantially the same price either has been or will be entered. No real change in ownership takes place.

31

What are the required disclosures before entering an order?

1.) Account number
2.) Whether the other is solicited, unsolicited or discretionary
3.) if a sale, whether long or short,
4.) terms and conditions of the order
5.) number of share if a stock, aggregate par value if a bond
6.) time of the order entry and executive
7.) name of the B/D and identify of the registered individual who accepted the order or is responsible for the account

32

Define control person?

An officer, director, or owner of more than 10% of the voting stock of the company, or the immediate family of any of these persons.

33

Define Treble damages?

A guilty party could be fined up to three times any ill-gotten gains or up to three times any losses avoided by using inside information to get out before a market drop.

34

What are the penalties one can face to those who were damaged by their insider trading?

1.) Limit of liability: Damages imposed will not exceed the profit gained or loss avoided in the transaction that are subject to the violation. There is no claim for treble damages.
2.) No action may be brought under this section more than five years after the date of the last transaction that is the subject of the violation

35

Explain the Chinese Wall Doctrine. aka Information Barrier

The procedures followed by firms to insulate information from the investment banking/ M&A side of the business from the retail broker/dealer side of the business to prevent from confidential information being leaked to the public.

36

What is the investigative authority of the SEC?

1.) Federal securities
2.) violation of the rules of SROs - national securities exchanges, FINRA, MSRB where the SEC can do the following:
administer oaths;
subpoena witnesses;
compel attendance;
require books and records be produced;
suspend trading in any nonexempt security for up to 10 days w/o prior notice;
suspend trading on an entire exchange for up to 90 days (must give prior notification to president of the US)

37

Explain the Uniform Net Capital Rule?

Establishes a minimum net capital requirements for broker/dealers. Net capital refers to net liquid assets of a firm. A B/D must at all times maintain a minimum amount of net capital for the protection of its customers. If it does not, it can not operate. The SEC also requires B/D's to maintain a fidelity bond.

38

What did the Securities Amendment Act of 1975 establish?

Removed barriers to competition in the securities industry. The SEC was given greater power to regulate the securities industry such as:
1.) fixed commission rates were abolished in favor of negotiated commissions on public orders
2.) Required registration of municipal securities dealers with the SEC. Previously, muni security dealers were exempt from registration. The amendment gave rise to the MSRB. However, the MSRB does not limit the powers of the SEC.
3.) SEC was given the power to regulate transfer agents.

39

What does the definition of an investment company NOT include?

broker/dealers and underwriters
2.) banks and savings and loans
3.) insurance companies
4.) holding companies.
5.) issuers whose securities are beneficially owned by no more than 100 perons
6.) issuers who trade in investment other than securities

40

How are open-end management company pricing offerings determined?

Based on net asset value which is calculated every business day at the close of the market?

41

How are close-end management company pricing offerings determined?

Based on supply and demand. Selling above net asset value and it is selling a premium, selling below is at discount.

42

When is a prospectus require for delivery for open-end investment companies?

prior to or concurrent with the sale

43

When is a prospectus require for delivery for close-end investment companies?

it is only required on the IPO

44

Explain the registration of investment companies?

They must register with the SEC and specifically as an investment company under the Investment Company Act of 1940.

45

Who are ineligible to serve in certain sensitive positions (director, employee, investment adviser, advisory board member, officer, principal underwriter) of investment company

1.) convicted, within the previous 10 yrs of any felony, or misdemeanor involving the purchase or sale of any security or arising out of that person's conduct as the underwriter, b/d, investment adviser, or affiliated person, salesmen of employee of the investment company
2.) permanently or temporarily enjoined by order, judgment or decree of any court from acting in any phase of a securities business

46

Explain asset-based sales load?

An asset-based sales load is any direct or indirect financing by a mutual fund of sales or
promotional services or activities in connection with the distribution of shares. This basically permits no-load funds to pay commissions (sometimes called trails) to broker-dealers
who sell or otherwise promote the sale of their fund shares.

47

What is the maximum 12b-1 charge for a mutual fund?

75 basis points + 25 basis points for as a servicing fee

48

directors who vote in favor of implementation or continuation of the plan must
believe that:

1.) it is likely that the plan will benefit the company, existing shareholders, and future shareholders;
2.) given the circumstances, the amounts payable under the plan and related agreements represent charges within the range of what would have been negotiated at arm’s length
as payment for the specific sales or promotional services and activities to be financed under the plan;
3.) the plan may be terminated at any time by a vote of the majority of the members of the board of directors of the company who are not interested persons of the company
and have no direct or indirect financial interest in the operation of the plan or in any related agreements, or by a vote of the majority of the shareholders of the company

49

Investment Companies are prohibits from engaging in what activities?

1.) purchase any security on margin
2.) participate in joint basis in any trading account in securities
3.) sell any security short
4.) acquire more than 3% of the outstanding voting securities of another investment company

50

What are examples of fundamental changes in investment policy?

1.) change in subclassification
2.) deviation from any fundamental policy in its registration statement, including a change in investment objective
3.) changing the nature of its business so as cease to be any investment company

51

What is the minimum net worth required for an investment company to make a public offering of securities?

$100,000

52

What are the the requirements in a contract to serve as an investment adviser for an investment company?

1.) describe all compensation to be paid
2.) will be approved annual by the board of director or by majority vote of the shareholders if the contract is to be renewed after the fist two years
3.) provide for termination anytime without penalty on not more than 60 days written notice
4.) provides for its automatic termination in the even of its assignment

53

It is unlawful for any affiliated person of, or principal underwriter for, a registered
investment company to:

1.) knowingly sell any security to that investment company unless it is a sale only of
shares issued by that company itself (redemption of the fund’s shares) or a sale of securities of which the seller is the issuer and which are part of a general public offering;
2.) borrow money or any other property from the fund; or
3.) knowingly purchase from that investment company any security other than the fund’s
shares

54

What is an affiliate person?

Any person directly or indirectly owning, controlling, or holding with power to vote 5% or more of the outstanding share of the investment company. It also includes any person directly or indirectly controlling, controlled by, or under common control with the investment company or any officer, director, partner, or employee of the investment company

55

Explain what role custodians play?

Every investment company is required to keep its assets with a custodian. If the custodian is a bank, the bank is NOT required to have FDIC coverage.

56

What is the breakpoint?

The quantity level stated in the prospectus at which investors receive a reduction in load. The breakpoint is available to any person who purchases in the stated quanity of the prospectus.

57

Who is the breakpoint limited to?

1.) an individual, spouse, and dependent children under age 21 purchasing in one more accounts
2.) any legitimate entity purchasing for its own account, as long as the entity was not formed for the purpose of making this purchase
3.) trustee purchasing on behalf of a qualified employee benefit plan, such as a pension or profit-sharing plan

58

Under what circumstances are the shares available at no sales charge?

Sales made to related persons of the fund such as officers and other employees of the fund, the adviser, or the principal underwriter
2.) shares purchased through automatic reinvestment of dividends and capital gain distributions

59

What reports must an investment company file with the SEC?

Audited balance sheet and income statement?

60

What are the semiannually shareholder mailed reports?

balance sheet, income statement, listing of the amounts and values of securities owned, statement of purchases and sales, statement of the remuneration paid by the investment during the period covered by the report to officers and directors and any person of whom any officer or director of the company is an affiliated person

61

What the penalties for larceny and embezzlement?

Whoever steals, unlawfully and willfully converts to his own use or to the use of
another, or embezzles any of the monies, funds, securities, or assets of any registered investment company will be deemed guilty of a crime and, upon conviction thereof, will be subject to the penalties of a fine of a maximum of $10,000, imprisonment for up to five years,
or both. In addition to these penalties, officers and directors of investment companies may
be subject to civil action by the SEC for various violations of the Investment Company
Act of 1940. If found guilty, you have the right to appeal within 60 days to the Federal
Court of Appeals for the District in which the case was heard.

62

What are the two types of mutual fund returns? and how are they calculated?

1.) Current: divide the yearly dividend paid from net investment income by the current offering price
2.) Total: add the capital gains to the dividends distributed. Total returns always assumes reinvestment of all distributions (dividends and capital gains)

63

Define money laundering?

Money laundering involves disguising financial assets so they can be utilized without
detecting the illegal activity that produced them. Through money laundering, a criminal transforms the proceeds of illicit activities into funds that appear to have been generated
by legal means. Money laundering enables criminals to hide and legitimize the proceeds
derived from illegal ventures.

64

Explain what are currency transaction reports?

The Bank Secrecy Act requires every financial institution to electronically file through
the Department of the U.S. Treasury, a currency transaction report (CTR) on FinCEN Form 112 for each cash transaction that exceeds $10,000. This requirement applies to
cash transactions used to pay off loans, the electronic transfer of funds, or the purchase of certificates of deposit, stocks, bonds, mutual funds, or other investments. The act also
requires the reporting of wire transfers in excess of $3,000.