Kaplan Chapter 1 Federal Securities Regulations

Kaplan Chapter 1 Federal Securities Regulations

• 5 questions on federal regulatory structure

MUST

• Compare and contrast the significant registration provisions and exemptions from the Securities Act of 1933
• Describe the registration requirements of the Securities Exchange Act of 1934 regarding exchanges, broker-dealers, and agents
• Describe the principal provisions of the Investment Company Act of 1940
• Discuss the disclosure requirements, antifraud provisions, and prohibitions against market manipulation under the Securities Exchange Act of 1934
• List prohibitions against market manipulation
• Recognize the application of the Insider Trading and Securities Fraud Enforcement Act of 1988

The Securities Act of 1933

• The Paper Act
• The Truth in Securities Act
• The Prospectus Act
• Regulates the issuing of corporate securities sold to the public
• IPO, initial public offering
• SPO, subsequent public offering
• Disclose issuer information to the SEC, Securities and Exchange Commission

Security

• Howey case decision
• The investment of money
• In a common enterprise (pool)
• With an expectation of profits
• From the efforts of others

Security Type

• Stock
• Bond
• Debenture
• Right or warrant
• Note
• Put, call, or other option
• Limited partnership interests
• Certificate of interest in a profit-sharing arrangement

Issuer

• Person who issues or proposes to issue any security
• Mostly business
• Can be a government

Underwriter

• A person who purchased from an issuer with a view to selling

Person

• Broad
• Individual
• Corporation
• Partnership
• Association
• Joint stock company
• Trust
• Unincorporated organization
• Government subdivision
• Political subdivision

Prospectus

• Any notice, circular, letter or communication, written or broadcast by radio or television
• Offers any security for sale or confirms the sale of a security

Sale

• Contract for sale
• Or disposition of a security for value

Quiz

The term issuer as defined in the Securities Act of 1933 would include

• A government entity issuing exempt securities
• A corporation issuing securities in an exempt transaction

Under the Securities Act of 1933, which of the following is not a security?

• A term life insurance policy

Review process

• The issuer file a registration statement with the SEC before securities are offered or sold in intrastate commerce
• A prospectus that meets the requirements of the act to be provided to prospective buyers
• Penalties (civil, criminal, or administrative) be imposed for violations of the act

Exempted Securities Under The Securities Act of 1933

• Registration MUST be in effect to sell or deliver security

EXEMPT

• Any security issued or guaranteed by the United States, any state, or any political subdivision of a state (all federal government issues and municipal securities are exempted securities)
• Any commercial paper that has a maturity at the time of issuance of no more than nine months (270 days), with the stipulation that the proceeds are to be used by the issuer to increase working capital and not for the purchase of fixed assets; there is no minimum amount or rating requirement
• Any security issued by a person organized and operated exclusively for religious, educational, benevolent, fraternal, or charitable purposes and not for a pecuniary profit
• Any interest in a railroad equipment trust
• Any security issued by a federal or state bank, savings and loan association, building and loan association, or similar institution

Rule 147

• Any security offered and sold only to persons resident within a single state or territory, where the issuer of such territory is a person resident and doing business within such state or territory
• The securities MUST be offered or sold exclusively to persons resident in 1 state; persons purchasing the securities must have their principal residence within the state
• For 9 months from the date of the last sale by the issuer of any part of the issue, resales of any part of the issue by any person will be made only to persons resident within the same state or territory. This will satisfy requirements that the issue come to rest in the state in order to claim the exemption
• At least 80% of the issuer’s gross revenue MUST be derived from operations within the state
• At least 80% of the proceeds of the offering MUST be used for business purposes within the state
• At least 80% of the issuer’s assets MUST be located within the state
• 80-80-80 rule
• No waivers

Other Exemptions

• Transactions by any person other than an issuer, underwriter, or dealer
• Transactions by any issuer that do not involve a public offering (private placement under Regulation D)

Registration Of Securities

• Requires registration of new issues that are to be distributed interstate
• Requires an issuer to provide full and fair disclosure of itself and the offering
• Requires an issuer to make available all material information necessary for an investor to judge the issue’s merit
• Regulates the underwriting and distribution of primary and secondary issues
• Provides criminal penalties for fraud in the issuance of new securities

The Registration Statement

• Purpose of issue
• Public offering price (anticipated range)
• Underwriter’s commissions or discounts
• Promotion expenses
• Expected use of the net proceeds of the issue to the company
• Balance sheet
• Earnings statements for the last 3 years
• Names, addresses, and bios of officers, directors, underwriters, and stockholders owning more than 10% of the outstanding stock (i.e. control persons)
• Copy of underwriting agreements
• Copies of articles of incorporation

The Cooling-Off Period

• 20-day period after the issuer files a registration statement with the SEC
• 1. Issuer files registration statement with the SEC
  2. Cooling off period
• 3. Effective date-offering period may begin
• Stop order, demands that all underwriting activities cease
• Deficiency letter, SEC finds something missing
• Stop order, SEC suspends the effectiveness of the registration

Preliminary (Red Herring) Prospectus

• MUST be made available to any prospective purchaser who expresses interest in the security from the time the issue is filed with the SEC until it becomes publicly available for sale
• A bona fide estimate of the price range per share is required to be included

Can’t be used:

• As a confirmation of sale
• In place of a registration statement
• To declare the final public offering price

Effective day

• Broker-dealer cannot accept money before the effective date
• Registration statement MUST be effective
• Red herring, preliminary prospectus

Cooling Off Period CAN NOT

• Take orders
• Distribute sales literature or advertising material
• Take indications of interest
• Distribute preliminary prospectuses
• Publish tombstone advertisements to provide information about the potential availability of the securities

The Final Effective Prospectus

• MUST be given to every person who purchase no later than with the confirmation of the sale

Rule 482 Omitting Prospectus

• Any information in the advertisement MUST be taken substantially from the regular prospectus
• The advertisement MUST state conspicuously from whom a prospectus may be obtained
• The advertisement MUST urge investors to read the prospectus carefully before investing
• Any past performance data, such as yields or return, that are quoted in the advertisement MUST be accompanied by appropriate disclaimers and disclosures of load
• The advertisement cannot be used to purchase the shares; purchase MAY be made ONLY via application in the prospectus

Effective Date of Registration Statement

• On the date a registration statement becomes effective, securities may be sold to the public by the investment bankers
• SEC disclaimer

Liabilities Under The Securities Act of 1933

• Every person who signed the registration form
• All directors of the issuer
• Attorneys
• Accountants
• Appraisers or other experts
• Underwriters
• Parent companies
• Statute of limitations for bringing action: 1 year after discovery or 3 years after date of the action

SEC abilities

• Make, amend, and rescind rules
• Administer oaths
• Subpoena witnesses and other records for evidence
• Seek injunctions or restraining orders in the appropriate court
• Turn over evidence to the attorney general of the United States for possible criminal prosecution
• Guilty, severe fine and can get barred from serving as an officer or director of a public corporation

SEC Regulation D

• Federal covered securities
• Company seeking to raise capital through a private placement under Rule 506(b) can sell the offering to an unlimited number of accredited investors and up to 35 non-accredited investors
• 506 c  permits the offering to be advertised
• Requirements: all purchasers are accredited investors AND issuer takes reasonable steps to verify that all investors are accredited investors

SEC Rule 501 Accredited Investors

• A bank, insurance company, or registered investment company
• An employee benefit plan if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million
• A charitable organization, corporation, or partnership with assets more than $5 million
• Directors, executive officers, and general partners of the issuer
• Any natural person whose individual net worth, or joint net worth with that person’s spouse exceeds $1 million at the time of purchase
• Any natural person who had an individual income in excess of $200,000 in each of the 2 most recent years or joint income with that person’s spouse in excess of $300,00 in each of those years and has a reasonable expectation of reaching the same income level in the current year
• Entities made up of accredited investors
• Accredited investor applies to private placements
• Can assets in an account or property held jointly with another person who is not the purchaser’s spouse be included in determining whether the purchaser satisfies the net worth test in Rule 501? Yes, assets in an account or property held jointly with a person who is not the purchaser’s spouse may be included in the calculation for the net worth test
• 506 (b) spouse with same residence (single purchaser), corporation or partnership is one purchaser

Accredited investors

• Purchases of securities by accredited investors do not count toward the 35-investor limitation found in Rule 506(b) of Regulation D

Form D

• No issuer that is issuing securities in reliance on Regulation D must file Form D with the SEC no later than 15 days after the first sale
• Form D must be filed 15 days prior to the first sale for those offerings made under 506© rather than the 15 days after as is the case with 506(b) offerings
• Restricted securities, unregistered securities purchased by an investor in a private placement, generally restricted from resale for a stated period of time
• Insiders, affiliates, unique status within the issuer
• Control stock, held by a control person
• Nonaffiliated, an investor who is not a control person and has no other affiliation with the issuer other than as an owner of the securities

Form 144

• Resales of existing securities

A man owns 15% of a company. His wife owns 5% of the stock of the same company. If the wife wishes to sell the stock she owns, which of the following statements are TRUE?

• Both the husband and wife are affiliates
• She must file under Rule 144

The Securities Exchange Act of 1934

• Grants SEC authority over all aspects of the securities industry
• NYSE New York Stock Exchange
• CHX Chicago Stock Exchange
• Nasdaq
• Empowers the SEC to require periodic reporting of information by companies with publicly traded securities

The Securities and Exchange Commission (SEC)

• 5 people
• SEC commissioners MAY NOT engage in any personal securities transactions other than in U.S. government issues
• Broker, any person engaged in the business of effecting transactions in securities for the account of others
• Dealer, any person regularly engaged in the business of buying and selling securities for his own account
• Person associated with a broker-dealer is any partner, officer, or director of the broker-dealer or any person directly or indirectly controlling or controlled by the broker-dealer including any employees of the broker dealer

Market Maker

• Dealer who holds himself out as being willing to buy and sell a particular security for his own account and on a regular or continuous basis

Securities Information Processor

• SIP
• Any person engaged in the business of collecting, processing, or preparing for distribution or publication information with respect to transactions in, or quotations for any nonexempt security OR
• Distributing or publishing (by ticker tape, a communications network, a terminal display device) on a current and continuing basis, information with respect to such transactions or quotations
• The Consolidated Ticker Tape
• OPRA (Options Price Reporting Authority)
• The OTC Markets Group Inc

NOT securities information processor

• A bona fide newspaper, news magazine, or business or financial publication of general or regular circulation like The Wall Street Journal
• Any SRO
• Any bank or broker-dealer supplying quotation and transaction information as part of its customary banking or brokerage business
• Any common carrier subject to the jurisdiction of the Federal Communications Commission or a state commission (radio and television stations)

Transfer Agent

• Any person who engages on behalf of an issuer in securities
• Countersigning the certificates
• Registering the transfer of the issuer’s securities
• Exchanging or converting the issuer’s securities
• Transferring record ownership of securities by bookkeeping entry without physical issuance of securities certificates

NOT a Transfer Agent

• Any insurance company or separate account that performs these functions solely with respect to variable annuity contracts or variable life policies that it issues
• Any registered clearing agency (e.g. Options Clearing Corporation) that performs these functions solely with respect to options contracts that it issues

Exchange

• An organization, association, or group of persons providing a marketplace or facilities for bringing together purchasers and sellers of securities
• Marketplace and facilities
• Exchanges MUST be registered
• Registration by filing an application with the SEC which will be accepted or denied within 90 days of application
• Formation of exchange is in the public interest
• The exchange will have compliance enforcement ability—the ability to enforce both the SEC’s and its own rules
• The board of directors will be represented by at least one member representing the investing public and at least one member representing listed companies
• The balance of the board is usually made up of directors representing the membership of the exchange
• Membership in the exchange can only be offered to registered broker-dealers or associated persons

Self-Regulatory Organization

• A national securities exchange or a registered securities organization such as FINRA

Security

• Equity security, stock or similar security
• Stock, common or preferred
• A security convertible into stock (convertible bond)
• Any security with a warrant or right attached to subscribe to or buy stock (e.g. a bond with warrants attached)
• Any warrant or right to purchase stock

Municipal Securities

• Securities that are direct obligations of or obligations guaranteed as to principal or interest by a state or political subdivision or any agent or instrumentality of a state
• Municipal bonds

Government Securities

• Securities that are direct obligations of or obligations guaranteed as to principal or interest by the U.S. government
• The term also includes government agencies

Statutory Disqualification

• Has been or is expelled or suspended from membership with respect to membership or participation in, or association with a member of an SRO
• Is subject to an order of the SEC or other appropriate regulatory agency denying, suspending for  a period not exceeding 12 months, or revoking his registration as a broker-dealer, or barring or suspending for a period not exceeding 12 months his association with a broker or dealer
• By his conduct while associated with a broker or dealer, has been found to be a cause of any effective suspension, expulsion, or order of the type described above
• Has associated with any person who is known, or with the exercise of reasonable care should be known, to him to be a person described by 1 or 3 criteria
• Has been convicted within the past 10 years of  a securities violation or a misdemeanor involving finance or dishonesty, bribery, embezzlement, forgery, theft, and so forth, or any felony
• Is subject to a temporary or permanent injunction from a competent court of jurisdiction prohibiting him from engaging in any phase of the securities business
• Has willfully violated any federal securities law
• Has made a false or misleading statement in any filing with information requested by an SRO (omitting important facts is cause as well)

Appropriate Regulatory Authority

• National securities exchanges
• Registered securities associations
• Members of an exchange or association
• Persons associated with a member
• Applicants to become a member or person associated with a member

Discretionary Authority

• Each discretionary order MUST be identified as such when it is entered for execution
• An officer or a partner of the firm must approve each order promptly and in writing, not necessarily before order entry
• A record MUST be kept of all transactions
• No excessive trading MAY occur in the account when considering the clients financial resources and investment objectives
• To safeguard against the possibility of churning, a designated supervisor or manager MUST review all trading activity frequently and systematically

Quiz

• An agent receives instructions from a client to buy 100 shares of KAPCO common stock at what the agent thinks is the best price. Two days later, the agent enters the order. The agent has acted inappropriately.
• Alice Allison is the president of Podunk University and sits on the board of directors of KAPCO Securities, a broker-dealer registered with the SEC. President Allison would be considered an associated person of KAPCO
• A securities order that is initiated by a client is what type of order? Unsolicited.

Registration Under The Securities Exchange Act of 1934

• Brokers and dealers operating in interstate commerce including those operating on exchanges and in the over-the-counter markets
• Securities exchanges (SEC has 90 days to accept or deny registration on an exchange)
• National securities associations such as FINRA and the MSRB
• Corporations with listed securities (a security may be registered on a national securities exchange by the issuer filing an application with the exchange and filing with the SEC as well
• The organization, the financial structure, and nature of the business
• The terms, position, rights, and privileges of the different classes of outstanding securities
• The terms on which their securities are to be and during the proceeding 3 years have been offered to the public
• The directors, officers, and underwriters and each security holder of record holding more than 10% of any class of equity security of the issuer, including their remuneration and their interests in the securities and their material contracts with the issuer and any person directly or indirectly controlling or controlled by the issuer
• Certified balance sheets for the previous 3 fiscal years prepared by independent public accountants
• Certified profit and loss statements for the proceeding 3 fiscal years prepared by independent accountants
• Securities information processors (SIPs)
• Transfer agents

Insider Transactions Under The Securities Exchange Act of 1934

• Every person who is directly or indirectly the beneficial owner of more than 10% of any class of equity security registered on a national securities exchange
• Officers or directors of the issuers of such securities
• SEC must be notified of any changes in the ownership of such securities
• Such individuals are prohibited from selling short and from engaging in short-term transactions usually called short-swing profits
• Gains, when purchase and sale occur within a 6 month period

Schedule 13D

• Section 13(d)-5% beneficial Owners generally requires a beneficial owner of more than 5% of a class of equity securities registered under the Securities Exchange Act of 1934 (equity securities of 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%
• The name and background of the person or entity (including partners, executive officers, directors, and controlling persons)
• The origin of the money for the acquisition of the securities
• The purpose of acquiring the securities such as to acquire control of the business of the issuer, and plans or proposals that such persons may have to liquidate the issuer, to sell its assets to or merge it with any other persons, or to make any other change to its business or corporate structure

Section 13(f) Filings

• Any institutional investment manager that uses the mail or any means or instrumentality of interstate commerce in the course of its business as a institutional investment manager and that exercises investment discretion over an equity portfolio with a market value on the last trading day in any of the proceeding 12 months of $100 million or more in 13(f) securities, must file a Form 13F with the SEC quarterly, within 45 days of the end of each quarter
• Exchange-traded (NYSE, CHX) or NASDAQ-quoted stocks, equity options and warrants, shares of closed-end investment companies, and certain convertible debt securities
• Mutual funds are NOT included
• ETFs are on the official list and ARE reported on Form 13F

Schedule G

• Regulation 13G was adopted to ease the beneficial ownership requirements for passive investors
• Instead of filing Schedule 13D, a passive investor whose beneficial ownership exceeds 5% of any registered security MAY file a Schedule 13G
• A passive investor, any person who can 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
• Investment companies and large pension funds are good examples of those that might have to file a Schedule 13G
• Passive investors who choose to file a Schedule 13G MUST do so within 10 calendar days after crossing the 5% threshold just as with a Schedule 13D

Section 16 Filings

• Section 16A of the Securities Exchange Act of 1934 requires executive officers, directors and greater than 10% stockholders (control persons) to file transaction reports before the end of the second business day following the day on which a transaction has been executed in an equity security where they are considered an insider

Credit Requirements (Margin)

• Regulation T
• From the Act of 1934
• How much credit MAY be extended by broker-dealers to their customers to purchase certain securities
• During the stock market crash in 1929, the margin requirements were 10%
• Today they are 50%
• Credit is NOT extended to new issue
• Underwriting syndicate MUST receive full payment for any new issue within 35 days
• Mutual funds may NOT be purchased on margin

Regulation Of The Use Of Manipulative And Deceptive Devices

• Churning, broker-dealer 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
• Wash trades, no change in the beneficial ownership of the security. When a person sells a security and repurchases it within 30 days prior to or after the sale and is covered in Unit 4
• Matched orders are illegal. Entering of a sell or buy order knowing that a corresponding buy (or sell) order of substantially the same size at substantially the same time and at substantially the same price either has been or will be entered

Order Tickets

• The account number
• Whether the order is solicited, unsolicited, or discretionary (including time or price)
• If a sale, whether Long or Short
• The terms and conditions of the order (market or limit)
• The number of shares if a stock and if a bond, aggregate par value
• The time of order entry and execution, and the execution price
• The name of the broker-dealer and identity of the registered individual who accepted the order or is responsible for the account

Insider Trading And Securities Fraud Enforcement Act of 1988

• An insider or control person is defined as 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
• Tippee is as guilty as the tipper
• Violation: trade securities on the basis of material, non-public information
• Treble damage, the guilty party could be fined up to 3 times any ill-gotten gains or up to 3 times any losses avoided by using inside information

Private Rights Of Action For Contemporaneous Trading

• Any person who violates the rules or regulations by purchasing or selling a security while in possession of material, non-public information shall be liable in an action in any court of competent jurisdiction to any person who purchased or sold is based on a purchase of securities of the same class
• The total amount of damages imposed will not exceed the profit gained or loss avoided in the transaction or transactions that are the subject of the violation
• No action MAY be brought under this section more than 5 years after the date of the last transaction that is subject of the violation

Chinese Wall Doctrine

• Research department and retail sales staff must be separated

Powers Of The SEC

• A national securities exchange
• The FINRA
• The MSRB
• Administer oaths
• Subpoena witnesses
• Compel attendance
• Require books and records to be produced
• Summarily suspend trading in any nonexempt security for up to 10 days without prior notice
• Suspend trading on an entire exchange for up to 90 days

Financial Responsibility Rules Under The Securities Exchange Act of 1934

• The SEC adopted SEC Rule 15c3-1 Uniform Net Capital Rule which establishes minimum net capital requirements for broker-dealers
• Net capital, net liquid assets of a firm
• A broker-dealer MUST at all times maintain a minimum amount of net capital for the protection of its customers
• If a firm does NOT have the required net capital under the rule, the SEC does not allow it to operate
• The SEC requires all broker-dealers to maintain a fidelity bond to protect against misappropriation, forgery, and similar violations

Securities Amendments Act of 1975

• Fixed commission rates were abolished. Negotiated commissions were adopted
• REQUIRES registration of municipal securities with the SEC
• The SEC was given the power to regulate the activities of transfer agents

Under The Securities Exchange Act of 1934 as amended, registration with the SEC would be required of

• A broker-dealer whose business is strictly municipal securities
• A broker-dealer whose business is strictly in non-Nasdaq over-the-counter securities

Investment Company Act of 1940

• Investment company, any issuer that is engaged in the business of investing in securities

NOT Investment Companies

• Broker-dealers and underwriters
• Banks and savings and loans
• Insurance companies
• Holding companies
• Issuers whose securities are beneficially owned by no more than 100 persons
• Issuers who trade in investments other than securities

Types Of Investment Companies

• Face-amount certificate company that issues face-amount certificates on the installment plan
• Security represents an obligation on the part of its issuer to pay a stated sum at a fixed date more than 24 months after the date of issuance
• If the investor discontinues the plan and cashes in before maturity, he will likely lose money
• Unit investment trust (UIT) is an investment company that does not have a board of directors and issues only redeemable securities each of which represents an undivided interest in a unit of specified securities
• Management company, any investment company other than a face-amount certificate company or a UIT

Which of the following would be considered investment companies under the Act of 1940?

• Face-amount certificate company
• Unit investment trust
• Management company

Open end

• Company continuously offers for sales
• Mutual Fund
• Redemption are made at NAV-redemption charge

Closed-End

• One-time offering of shares
• Pricing is not NAV
• Pricing is supply and demand

How do closed-end investment companies differ from open-end investment companies?

• The only time a prospectus is used with the sale of a closed-end company is on the IPO; sales of open-end shares must always be preceded or accompanied by a prospectus
• Closed-end companies issue a fixed number of shares; open-end companies issue new shares

A financial reporter notices that the quoted price of one investment company’s shares is at a 22% discount from the NAV. From this information, it can be deduced that the company MUST be

• A closed-end investment company

Registration Of Investment Companies

• Investment companies MUST register by filing with SEC under the Securities Act of 1933
• They MUST register as investment companies under the Investment Company Act of 1940

Ineligibility of Certain Affiliated Persons and Underwriters

• The Investment Act of 1940 prohibits people who have committed certain acts from serving in certain sensitive positions with an investment company, its adviser, or its principal underwriter
• No serving if convicted of any felony or misdemeanor involving purchase/sale of security
• Permanently enjoined by order, judgment, or decree

Rule 12b-1

• Payment of Asset-Based Sales Loads by Registered Open-End Management Investment Companies
• Mutual fund can distribute its own shares without the use of an underwriter
• Asset-based sales load, any direct or indirect financing by a mutual fund
• Trails, no-load funds to pay commissions
• Mutual fund MAY NOT use the term no-load if its 12b-1 fee exceeds .25% (25 basis points)
• Under any circumstances the maximum 12b-1 charge may not exceed .75%
• Written plan has been approved by a vote of at least a majority of the outstanding voting securities
• The plan has been approved by a vote of the board of directors of the company
• Plan must benefit the company, existing shareholders, and future shareholders
• Given the circumstances, the amounts payable under the plan represent charges within the range of what would have been negotiated for specific sales or promotional services
• The plan may be terminated by a vote of the majority of the members
• All of the following statements regarding a 12b-1 company are TRUE
  the plan may be terminated by a vote of the majority of shareholders or a majority of the board of directors

Prohibited Activities of Investment Companies

• MAY NOT purchase any security on margin
• MAY NOT participate on a joint basis in any trading account in securities
• Sell any security short
• Acquire more than 3% of the outstanding voting securities of another investment company

The Investment Company Act of 1940 prohibits registered investment companies from engaging in any of the following practices EXCEPT

• Issuing common stock

Changes In Investment Policy

• Change in subclassification such as from open-end to closed-end or from diversified to non-diversified
• Deviation from any fundamental policy in its registration statement including a change in investment objective
• Changing the nature of its business so as to cease to be an investment company

Size of Investment Companies

• Net worth MUST be $100,000 to make a public offering

Investment Advisory and Underwriter Contracts

• Precisely describes all compensation to be paid
• Will be approved at least annually by the board of directors or by majority vote of the shareholders if it is to be renewed after the first 2 years
• Provides that it may be terminated at any time, without penalty by the board of directors or by majority vote of the shareholders on not more than 60 days’ written notice to the investment adviser
• Provides for its automatic termination in the event of its assignment

Transactions of Certain Affiliated Persons and Underwriters

• 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
• Borrow money or any other property from the fund
• Knowingly purchase from that investment company any security other than the fund’s shares

Affiliated person

• Any person directly or indirectly owning, controlling, or holding with power to vote, 5% or more of the outstanding shares of the investment company

Custodian

• Firewall
• Custodian bank to make it difficult for affiliates to have access to assets of the fund

ABC is a FINRA member broker-dealer. Among other functions, it serves as the principal underwriter of the XYZ Mutual Fund. Which of the following transactions would be prohibited unless exemptive relief was offered by the SEC?

• ABC purchases some securities directly from XYZ’s portfolio

Which of the following statements correctly expresses requirements under the Investment Company Act of 1940?

• No investment advisory contract may be entered into that does not provide for termination with no more than 60 days notice in writing
• No registered investment company may acquire more than 3% of the shares of another investment company

Sale of Redeemable Securities

• Breakpoint, reduction in load
• An individual, spouse, and dependent children under age 21 in purchasing in 1 or more accounts
• Any legitimate entity purchasing for its own account as long as the entity was not formed for the purpose of making this purchase
• The trustee purchasing on behalf of a qualified employee benefit plan such as a pension or profit-sharing plan

NO Special Breakpoint

• Purchases made for the account of an investment club
• Purchases made on behalf on any entity or group that does not have a common purpose

No Sales Charge

• Made to related purposes of the fund such as officers and employees
• Shares purchased through automatic reinvestment of dividends

Commissions

• Can’t be used as a credit against advisory fees

Under which of the following circumstances would a purchase of mutual fund shares at a price below the public offering price be allowable?

• A parent buys enough to reach the breakpoint but places half the order in his account and the other half in an account for which his wife is designated as custodian for their son
• The receptionist for XYZ Growth Fund purchases $100 of that fund

Periodic And Other Reports

• Investment companies MUST file annual financial reports with the SEC

Shareholder Reports

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

Unlawful Representations And Names

• It is UNLAWFUL for any person, in issuing or selling any security of which a registered investment company is the issuer, to represent that a security/company has been guaranteed, sponsored, recommended, or approved by the U.S. government

Larceny And Embezzlement

• Fine maximum $10,000
• Imprisonment of up to 5 years
• Or both
• If guilty, right to appeal within 60 days to the Federal Court of Appeals for the District

Computing Returns Of Mutual Fund Shares

• Current=yearly dividend paid from net investment income/current offering price
• Total

The KAPCO Income Fund has a current public offering price of $10.50 and a net asset value per share of $10.00. During the past 12 months, the fund has made 4 quarterly distributions from net investment income of .15 and one distribution from capital gains in the amount of $0.25. The fund’s current yield is?

5.7%.

• Annual income is 4 x .15=.$60
• .60/$10.50 (POP)

Total Return on Mutual Fund Shares

• Capital gains + dividends distributed

Money Laundering

• Disguise financial assets so they can be utilized without detecting the illegal activity that produced them

Currency Transaction Reports

• Every time each cash transaction is greater than $10,000
• Transactions to pay off loans, the electronic transfer of funds, or the purchase of certificates of deposit, stocks, bonds, mutual funds, or other investments
• Report wire transfers > $3,000

The National Securities Markets Improvement Act of 1996

• Amend Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940
• Created Federal Covered Adviser designation
• State securities registration requirements were designed with respect to federal covered securities