Exam (elaborations) [WILEY FINRA SERIES] SECURITIES INSTITUTE OF AMERICA - Wiley Series 63 Exam Review 2016 + TEST BANK The Uniform Securities

Exam (elaborations) [WILEY FINRA SERIES] SECURITIES INSTITUTE OF AMERICA - Wiley Series 63 Exam Review 2016 + TEST BANK The Uniform Securities WILEY SERIES 63 EXAM REVIEW 2016 The Uniform Securities State Law Examination The Securities Institute of America, Inc. Cover Design: Wiley Cover Image: © iS / LuisB Copyright © 2016 by The Securities Institute of America, Inc. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Previous editions published by The Securities Institute of America, Inc. Published simultaneously in Canada. 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ISBN 978-1-119-11245-7 (Paperback) ISBN 978-1-119-13886-0 (ePDF) ISBN 978-1-119-13885-3 (ePub) Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1 Contents ABOUT THE SERIES 63 EXAM ix ABOUT THIS BOOK xiii ABOUT THE TEST BANK xv ABOUT THE SECURITIES INSTITUTE OF AMERICA xvii CHAPTER 1 FEDERAL LAW REVIEW 1 The Securities Act of 1933 1 The Prospectus 2 The Final Prospectus 2 Misrepresentations 3 The Securities Exchange Act of 1934 3 Net Capital Requirement 7 Customer Coverage 7 Fidelity Bond 8 The Insider Trading and Securities Fraud Enforcement Act of 1988 8 Firewall 9 The Telephone Consumer Protection Act of 1991 9 National Securities Market Improvement Act of 1996 10 vi Contents The Uniform Securities Act 11 The Uniform Prudent Investors Act of 1994 12 CHAPTER 2 DEFINITIONS OF TERMS 13 Security 13 Person 15 Broker Dealer 16 Pension Consultants 18 Investment Counsel 18 Form ADV 19 Investment Adviser Registration Database (IARD) 20 Investment Adviser Representative 20 Offer/Offer to Sell/Offer to Buy 23 Sale/Sell 23 Guarantee/Guaranteed 23 Contumacy 24 Federally Covered Exemption 24 Power of Attorney 24 Pretest 25 CHAPTER 3 REGISTRATION OF BROKER DEALERS, INVESTMENT ADVISERS, AND AGENTS 31 Registration of Broker Dealers and Agents 31 Agent Registration 32 Registering Broker Dealers 33 Financial Requirements 34 Broker Dealers on the Premises of Other Financial Institutions 34 Registering Agents 35 Canadian Firms and Agents 36 Investment Adviser Registration 37 The National Securities Market Improvement Act of 1996/The Coordination Act 37 Contents vii Investment Adviser Representative 38 Investment Adviser Registration 39 Capital Requirements 39 Exams 40 Advertising and Sales Literature 41 Brochure Delivery 42 Wrap Accounts 43 Pretest 45 CHAPTER 4 SECURITIES REGISTRATION, EXEMPT SECURITIES, AND EXEMPT TRANSACTIONS 49 Exempt Securities 49 Securities Registration 50 Registration of IPOs Through Coordination 50 Registration Through Notice Filing 51 Registration of Non-Established Issuers/Registration Through Qualification 51 Exempt Securities/Federally Covered Exemption 53 Exempt Transactions 54 Pretest 59 CHAPTER 5 PROFESSIONAL CONDUCT AND PROHIBITED AND FRAUDULENT ACTIONS 65 Fraud 65 Professional Conduct 66 Suitability 66 Market Manipulation 68 Customer Complaints 69 The Role of the Investment Adviser 69 Additional Compensation for an Investment Adviser 70 Agency Cross Transactions 70 Disclosures by an Investment Adviser 70 Investment Adviser Contracts 72 Private Investment Companies/Hedge Funds 72 Fulcrum Fees 72 Soft Dollars 73 Borrowing and Lending Money 74 Pretest 75 CHAPTER 6 THE STATE SECURITIES ADMINISTRATOR AND THE UNIFORM SECURITIES ACT 83 Actions by the State Securities Administrator 83 Cancellation of a Registration 84 Withdrawal of a Registration 85 Actions Against an Issuer of Securities 85 Rule Changes 85 Administrative Orders 85 Interpretive Opinions 87 Administrative Records 87 Investigations 88 Civil and Criminal Penalties 88 Jurisdiction of the State Securities Administrator 89 Administrator’s Jurisdiction over Securities Transactions 90 Radio Television and Newspaper Distribution 92 Right of Rescission 93 Statute of Limitations 93 Pretest 95 ANSWER KEYS 101 GLOSSARY OF EXAM TERMS 109 INDEX 175 viii Contents About the Series 63 Exam Congratulations! You are on your way to becoming a registered representative licensed to conduct securities business in all states that require the Series 63. The Series 63 exam will be presented in a 60-question multiple-choice format. Each candidate will have one hour and 15 minutes to complete the exam. A score of 72% or higher is required to pass. The Series 63 is as much a knowledge test as it is a reading test. The writers and instructors at The Securities Institute have developed the Series 63 textbook, exam prep software, and videos to ensure that you have the knowledge required to pass the test and to make sure that you are confident in the application of the knowledge during the exam. IMPORTANT EXAM NOTE The series 63 exam is based on the provisions of the Uniform Securities Act not on any of the amendments enacted by any particular state or state securities administrator. The Uniform Securities Act may be referred to as the USA or as the Act. Test takers should treat these terms as interchangeable. TAKING THE SERIES 63 EXAM The Series 63 exam is presented in multiple-choice format on a touch-screen computer known as the PROCTOR system. No computer skills are required, and candidates will find that the test screen works in the same way as an ordinary ATM. Each test is made up of 60 questions that are randomly chosen from a test bank containing several thousand questions. The test has a time limit of one hour and 15 minutes and is designed to provide enough time x WILEY SERIES 63 Exam Review 2016 for all candidates to complete the exam. Each Series 63 exam will have five additional questions that do not count towards the final score. The Series 63 comprises questions that focus on the following areas: State securities rules and regulations 36 questions 60% Ethical practices & fiduciary obligations 24 questions 40% TOTAL 60 questions 100% HOW TO PREPARE FOR THE SERIES 63 EXAM For most candidates, the combination of reading the textbook, watching the videos, and using the exam prep software is enough to successfully complete the exam. It is recommended that the candidate spend at least 30 hours preparing for the exam by reading the textbook, underlining key points, watching the video class, and completing as many practice questions as possible. We recommend that candidates schedule their exam no more than one week after completing their Series 63 exam prep. Test-Taking Tips □□Read the full question before answering. □□Identify what the question is asking. □□Identify key words and phrases. □□Watch out for hedge clauses, for example, except and not. □□Eliminate wrong answers. □□Identify synonymous terms. □□Be wary of changing answers. HOW MUCH HAS THE SERIES 63 EXAM CHANGED? Over the last several years, the Series 63 exam has been made significantly more challenging. The North American Securities Administrators Association (NASAA) has increased the percentage of the exam that concentrates on the National Securities Market Improvement Act of 1996. On April 1, 2002, NASAA increased the number of total questions on the exam by 20%, from 50 to 60. The passing score was increased to 72% on January 1, 2010. Each test will also contain practice questions that are not graded. WHY DO I NEED TO TAKE THE SERIES 63 EXAM? In order to conduct securities business, most states require that an agent successfully complete the Series 63, in addition to obtaining a Series 6, 7, or 62 registration. WHAT SCORE IS NEEDED TO PASS THE EXAM? A score of 72% or higher is needed to pass the Series 63 exam. ARE THERE ANY PREREQUISITES FOR THE SERIES 63? A candidate is not required to have any other professional qualifications prior to taking the Series 63 exam. HOW DO I SCHEDULE AN EXAM? Ask your firm’s principal to schedule the exam for you or to supply you with a list of test centers in your area. If you are not with a member firm, you may obtain a Form U10 from the North American Securities Administrators Association (NASAA) to make an appointment. The Series 63 exam may be taken any day that the exam center is open. WHAT MUST I TAKE TO THE EXAM CENTER? A picture ID is required. All other materials will be provided, including a calculator and scratch paper. HOW SOON WILL I RECEIVE THE RESULTS OF THE EXAM? The exam will be graded as soon as you answer your final question and hit the Submit for Grading button. It will take only a few minutes to get your About the Series 63 Exam xi xii WILEY SERIES 63 Exam Review 2016 results. Your grade will appear on the computer screen, and you will be given a paper copy from the exam center. If you do not pass the test, you will need to wait 30 days before taking it again. If you do not pass on the second try, you will need to wait another 30 days. If you fail a third time, you are required to wait six months to take the test again. About This Book The writers and instructors at The Securities Institute have developed the Series 63 textbook, exam prep software, and videos to ensure that you have the knowledge required to pass the test, and to make sure that you are confident in the application of the knowledge during the exam. The writers and instructors at The Securities Institute are subject-matter experts as well as Series 63 test experts. We understand how the test is written, and our proven test-taking techniques can dramatically improve your results. Each chapter includes notes, tips, examples, and case studies with key information, hints for taking the exam, and additional insight into the topics. Each chapter ends with a practice test, to ensure that you have mastered the concepts before moving on to the next topic. About the Test Bank This book is accompanied by a test bank of approximately 200 questions to further reinforce the concepts and information presented here. The access card in the back of this book includes the URL and PIN code you can use to access the test bank. This test bank provides a small sample of the questions and features that are contained in the full version of the Series 63 exam prep software. If you have not purchased the full version of the exam prep software with this book, we highly recommend it to ensure that you have mastered the knowledge required for your Series 63 exam. To purchase the exam prep software for this exam, visit The Securities Institute of America online at www.SecuritiesCE.com or call . About The Securities Institute of America The Securities Institute of America, Inc. helps thousands of securities and insurance professionals build successful careers in the financial services industry every year. Our securities training options include: • Onsite training classes. • Private tutoring. • Classroom training. • Interactive online video training classes. • State-of-the-art exam preparation software. • Printed textbooks. • Real-time tracking and reporting for managers and training directors. You can choose a securities training solution that matches your skill level, learning style, and schedule. Regardless of the format you choose, you can be sure that our securities training courses are relevant, tested, and designed to help you succeed. It is the experience of our instructors and the quality of our materials that make our courses requested by name at some of the largest financial services firms in the world. To contact The Securities Institute of America, visit us on the Web at www.SecuritiesCE.com or call . CHAPTER 1 Federal Law Review INTRODUCTION Although the Series 63 exam is a state-based exam, a full understanding of federal securities laws is required. All federal securities laws have a year attached to them that corresponds with the year the law was enacted. THE SECURITIES ACT OF 1933 The Securities Act of 1933 was the first major piece of securities industry regulation, which was brought about largely as a result of the stock market crash of 1929. Other laws were also enacted to help prevent another meltdown of the nation’s financial system, such as the Securities Exchange Act of 1934, which will be discussed later. The Securities Act of 1933 regulates the primary market. The primary market consists exclusively of transactions between issuers of securities and investors. In a primary market transaction, the issuer of the securities receives the proceeds from the sale of the securities. The Securities Act of 1933 requires nonexempt issuers, typically corporate issuers, to file a registration statement with the Securities and Exchange Commission (SEC). The SEC will review the registration statement for a minimum of 20 days. During this time, known as the cooling-off period, no sales of securities may take place. If the SEC requires additional information regarding the offering, the SEC may issue a deficiency letter or a stop order that will extend the cooling-off period beyond the original 20 days. The cooling-off period will continue until 2 WILEY SERIES 63 Exam Review 2016 the SEC has received all of the information it has requested. The registration statement, formally known as an S1, is the issuer’s full disclosure document for the registration of the securities with the SEC. THE PROSPECTUS While the SEC is reviewing the securities’ registration statement, registered representatives are very limited as to what they may do with regard to the new issue. During the cooling-off period, the only thing a registered representative may do is obtain indications on interest from clients by providing them with a preliminary prospectus, also known as a red herring. The term “red herring” originated from the fact that all preliminary prospectuses must have a statement printed in red ink on the front cover stating, “These securities have not yet become registered with the SEC and therefore may not be sold.” An indication of interest is an investor’s or broker dealer’s statement that it may be interested in purchasing the securities being offered. The preliminary prospectus contains most of the same information that will be contained in the final prospectus except for the offering price and the proceeds to the issuer. All information contained in a preliminary prospectus is subject to change or revision. THE FINAL PROSPECTUS All purchasers of new issues must be given a final prospectus before any sales may be allowed. The final prospectus serves as the issuer’s full-disclosure document for the purchaser of the securities. If the issuer has filed a prospectus with the SEC and the prospectus can be viewed on the SEC’s website, a prospectus will be deemed to have been provided to the investor through the “access equals delivery” rule. Once the issuer’s registration statement becomes effective, the final prospectus must include the following: • Type and description of the securities • Price of the securities • Use of the proceeds • Underwriter’s discount • Date of offering • Type and description of underwriting • Business history of issuer CHAPTER 1 Federal Law Review 3 • Biographical data for company officers and directors • Information regarding large stockholders • Company financial data • Risks to purchaser • Legal matters concerning the company • SEC disclaimer SEC DISCLAIMER The SEC reviews the issuer’s registration statement and the prospectus but does not guarantee the accuracy or adequacy of the information. The following SEC disclaimer must appear on the cover of all prospectuses: “These securities have not been approved or disapproved by the SEC nor have any representations been made about the accuracy or the adequacy of the information.” MISREPRESENTATIONS Financial relief for misrepresentations made under the Securities Act of 1933 is available for purchasers of any security that is sold under a prospectus that is found to contain false or misleading statements. Purchasers of the security may be entitled to seek financial relief from any or all of the following: 1. The issuer. 2. The underwriters. 3. Officers and directors. 4. All parties who signed the registration statement. 5. Accountants and attorneys who helped prepare the registration statement. THE SECURITIES EXCHANGE ACT OF 1934 The Securities Exchange Act of 1934 was the second major piece of legislation that resulted from the market crash of 1929. The Securities Exchange Act of 1934 regulates the secondary market, which consists of investor-to-investor transactions. All transactions between two investors that are executed on any of the exchanges or in the over-the-counter (OTC) market are secondary market transactions. In a secondary market transaction, the selling security holder 4 WILEY SERIES 63 Exam Review 2016 receives the money, not the issuing corporation. The Securities Exchange Act of 1934 also regulates all individuals and firms that conduct business in the securities industry. The Securities Exchange Act of 1934: • Created the SEC. • Requires registration of broker dealers and agents. • Regulates the exchanges and the National Association of Securities Dealers (the NASD is now part of FINRA). • Requires net capital for broker dealers. • Regulates short sales. • Regulates insider transactions. • Requires public companies to solicit proxies. • Requires segregation of customer and firm assets. • Authorizes the Federal Reserve Board to regulate the extension of credit for securities purchases under Regulation T. • Regulates the handling of client accounts. THE SECURITIES AND EXCHANGE COMMISSION (SEC) One of the biggest components of the Securities Exchange Act of 1934 was the creation of the SEC. The SEC is the ultimate securities industry authority, and it is a government body. Five commissioners are appointed to five-year terms by the president, and each must be approved by the Senate. The SEC is neither a self-regulatory organization (SRO) nor a designated examining authority (DEA). A self-regulatory organization regulates its own members, such as the New York Stock Exchange (NYSE) or FINRA. A DEA inspects a broker dealer’s books and records; it can also be the NYSE or FINRA. All broker dealers, exchanges, agents, and securities must register with the SEC. All exchanges are required to file a registration statement with the SEC that includes the articles of incorporation, bylaws, and constitution. All new rules and regulations adopted by the exchanges must be disclosed to the SEC as soon as they are enacted. Issuers of securities with more than 500 shareholders and with assets exceeding $5,000,000 must register with the SEC, file quarterly and annual reports, and solicit proxies from stockholders. A broker dealer that conducts business with the public must register with the SEC and maintain a certain level of financial solvency, known as net capital. All broker dealers are required to forward a financial statement to all customers of the firm. Additionally, all employees CHAPTER 1 Federal Law Review 5 of the broker dealer involved in securities sales who have access to cash and securities or who supervise employees must be fingerprinted. EXTENSION OF CREDIT The Securities Act of 1934 gave the authority to the Federal Reserve Board to regulate the extension of credit by broker dealers for the purchase of securities by their customers. The following is a list of the regulations of the different lenders and the regulation that gave the Federal Reserve Board the authority to govern their activities: • Regulation T: Broker dealers • Regulation U: Banks • Regulation G: All other financial institutions PUBLIC UTILITIES HOLDING COMPANY ACT OF 1935 The Public Utilities Holding Company Act of 1935 regulates all companies that are in business to provide retail distribution of gas and electric power. Because the companies are regulated by this act, their securities are exempt from state registration requirements. THE MALONEY ACT OF 1938 /NASD The Maloney Act of 1938 was an amendment to the Securities Exchange Act of 1934 that allowed the creation of the NASD. The NASD is the SRO for the OTC market. Its purpose is to regulate the broker dealers that conduct business in the OTC market. The NASD (now part of FINRA) is organized into four major bylaws. They are: 1. The Rules of Fair Practice. 2. The Uniform Practice Code. 3. The Code of Procedure. 4. The Code of Arbitration. THE TRUST INDENTURE ACT OF 1939 The Trust Indenture Act of 1939 requires that corporate bond issues in excess of $5,000,000 that are to be repaid during a term in excess of one 6 WILEY SERIES 63 Exam Review 2016 year issue a trust indenture for the issue. The trust indenture is a contract between the issuer and the trustee. The trustee acts on behalf of all of the bondholders and ensures that the issuer is in compliance with all of the promises and covenants made to the bondholders. The trustee is appointed by the corporation and is usually a bank or a trust company. The Trust Indenture Act of 1939 only applies to corporate issuers. Both federal and municipal issuers are exempt. INVESTMENT ADVISERS ACT OF 1940 The Investment Advisers Act of 1940 regulates industry professionals who charge a fee for the advice they offer to clients. The Investment Advisers Act sets forth registration requirements for advisers as well as disclosure requirements relating to the adviser’s: • Methods of recommendations • Types of securities recommended • Professional background and qualifications • Fees to be charged • Method for computing and charging fees • Types of clients INVESTMENT COMPANY ACT OF 1940 The Investment Company Act of 1940 regulates companies that are in business to invest or reinvest money for the benefit of its investors. The Investment Company Act sets forth registration requirements for the three types of investment companies. They are: 1. Management investment companies. 2. Unit investment trusts (UITs). 3. Face-amount companies (FACs). SECURITIES INVESTOR PROTECTION CORPORATION ACT OF 1970 (SIPC) The Securities Investor Protection Corporation (SIPC) is a governmentsponsored corporation that provides protection to customers in the event of a broker dealer’s failure. All broker dealers that are registered with the SEC are CHAPTER 1 Federal Law Review 7 required to be SIPC members. All broker dealers are required to pay annual dues to SIPC’s insurance fund to cover losses due to broker dealer failure. If a broker dealer fails to pay its SIPC assessment, it may not transact business until it is paid. NET CAPITAL REQUIREMENT All broker dealers are required to maintain a certain level of net capital in order to ensure that they are financially solvent. A broker dealer’s capital requirement is contingent on the type of business that it conducts. The larger and more complex the firm’s business, the greater the net capital requirement. Should a firm fall below its net capital requirement, it is deemed to be insolvent, and SIPC will petition in court to have a trustee appointed to liquidate the firm and protect the customers. The trustee must be a disinterested party; once the trustee is appointed, the firm may not conduct business or try to conceal any assets. CUSTOMER COVERAGE SIPC protects customers of a brokerage firm in much the same way that the Federal Deposit Insurance Corporation (FDIC) protects customers of banks. SIPC covers customer losses that result from broker dealer failure, not market losses. SIPC covers customers for up to $500,000 per separate customer. Of the $500,000, up to $250,000 may be in cash. Most broker dealers carry additional private insurance to cover larger accounts, but SIPC is the industry-funded insurance and is required by all broker dealers. The following are examples of separate customers: Customer Securities Market Value Cash SIPC Coverage Mr. Jones $320,000 $75,000 All Mr. & Mrs. Jones $290,000 $90,000 All Mrs. Jones $397,000 $82,000 All All of the accounts shown would be considered separate customers, and SIPC would cover the entire value of the accounts. If an account has in excess of $250,000 in cash, the individual would not be covered for any amount exceeding $250,000 in cash and would become a general creditor for the rest. SIPC does not consider a margin account and a cash account as 8 WILEY SERIES 63 Exam Review 2016 separate customers, and the customer would be covered for the maximum of $500,000. SIPC does not offer coverage for commodities contracts, and all member firms must display the SIPC sign in the lobby of the firm. FIDELITY BOND All SIPC members are required to obtain a fidelity bond to protect customers in the event of employee dishonesty. Some things that a fidelity bond will insure against are check forgery and fraudulent trading. The minimum amount of the fidelity bond is $25,000; however, large firms are often required to carry a higher amount. THE INSIDER TRADING AND SECURITIES FRAUD ENFORCEMENT ACT OF 1988 The Insider Trading and Securities Fraud Enforcement Act of 1988 set forth guidelines and controls for the use and dissemination of nonpublic material information. Nonpublic information is information that is not known by people outside of the company. Material information is information regarding a situation or development that will materially affect the company in the present or future. It is not only just for insiders to have this type of information, but it is required for them to do their jobs effectively. It is, however, unlawful for an insider to use this information to profit from a forthcoming move in the stock price. An insider is defined as any officer, director, 10% stockholder, or anyone who is in possession of nonpublic material information, as well as the spouse of any such person. Additionally, it is unlawful for the insider to divulge any of this information to any outside party. Trading on inside information has always been a violation of the Securities Exchange Act of 1934, but the Insider Trading Act prescribed penalties for violators, which include: • A fine of the greater of 300% of the amount of the gain or 300% of the amount of the loss avoided, or $1,000,000 for the person who acts on the information • A fine of up to $1,000,000 for the person who divulges the information • Insider traders may be sued by the affected parties • Criminal prosecutions CHAPTER 1 Federal Law Review 9 Information becomes public information once it has been disseminated over public media. The SEC will pay a reward of up to 10% to informants who turn in individuals who trade on inside information. In addition to the insiders already listed, the following are also considered insiders: • Accountants • Attorneys • Investment bankers FIREWALL Broker dealers who act as underwriters and investment bankers for corporate clients must have access to information regarding the company in order to advise the company properly. The broker dealer must ensure that no inside information is passed between its investment banking department and its retail trading department. The broker dealer is required to physically separate these divisions by a firewall. The broker dealer must maintain written supervisory procedures to adequately guard against the wrongful use or dissemination of inside information. THE TELEPHONE CONSUMER PROTECTION ACT OF 1991 The Telephone Consumer Protection Act of 1991 regulates how telemarketing calls are made by businesses. Telemarketing calls that are designed to have consumers invest in or purchase goods, services, or property must adhere to the strict guidelines of the act. All firms must: • Call only between the hours of 8 a.m. and 9 p.m. in the customer’s time zone. • Maintain a Do-Not-Call list. Individuals placed on the Do-Not-Call list may not be contacted by anyone at the firm for five years. • Give the prospect the firm’s name, address, and phone number when soliciting. • Follow adequate policies and procedures to maintain a Do-Not-Call list. • Train representatives on calling policies and use of the Do-Not-Call list. • Ensure that any fax solicitations have the firm’s name, address, and phone number. 10 WILEY SERIES 63 Exam Review 2016 EXEMPTION FROM THE TELEPHONE CONSUMER PROTECTION ACT OF 1991 The following are exempt from the Telephone Consumer Protection Act of 1991: • Calls to existing customers • Calls to a delinquent debtor • Calls from a religious or nonprofit organization Calls may be made prior to 8 a.m. or after 9 p.m. to places of business. The time regulation only relates to contacting noncustomers at home. NATIONAL SECURITIES MARKET IMPROVEMENT ACT OF 1996 The National Securities Market Improvement Act of 1996, also known as the Coordination Act, eliminated the duplication of effort among state and federal regulators. Some of the key points of the act include: • Federal law supersedes state law. • Registration of investment advisers. • Capital requirements. • Industry competition. The National Securities Market Improvement Act of 1996 ensured that no action by any state or political subdivision could impose laws or requirements upon any broker dealer that differed from or are in addition to those of the Securities Exchange Act of 1934 relating to: • Capital requirements. • Recordkeeping. • Financial reporting. • Margin. • Custody. The National Securities Market Improvement Act of 1996 also set forth that the states did not have any authority to regulate investment advisory CHAPTER 1 Federal Law Review 11 firms that are federally registered. However, the states may require an investment advisory representative of a federally registered investment adviser to register with the state. THE UNIFORM SECURITIES ACT In the early half of the twentieth century, state securities regulators developed rules and regulations for transacting securities business within their states. The result was regulations that varied widely from state to state. The Uniform Securities Act (USA) laid out model legislation for all states in an effort to make each state’s rules and regulations more uniform and easier to address. The USA, or the Act, sets minimum qualifications and standards for each state securities administrator. The state securities administrator is the top securities regulator within the state. The state securities administrator may be the attorney general or it may be an individual appointed specifically to that post. The USA also: • Prohibits the state securities administrator from using the post for personal benefit or from disclosing information. • Gives the state securities administrator authority to enforce the rules of the USA within that state. • Gives the administrator the ability to set certain registration requirements for broker dealers, agents, and investment advisers. • Allows administrators to set fee and testing requirements. • Permits administrators to suspend or revoke the state registration of a broker dealer, agent, investment adviser, a security, or a security’s exemption from registration. • Sets civil and criminal penalties for violators. The state-based laws set forth by the USA are also known as blue sky laws. Collectively the State Securities Administrators from each state make up the North American Securities Administrators Association or NASAA. The North America Securities Administrators’ Association is a body of state regulators each of whom is responsible for administering the provisions of the Uniform Securities Act within their state. Together they make up an advisory committee that refines and amends the Uniform Securities Act through the adoption of module rules and policy statements. NASAA is also responsible for creating the content tested on the series 63, 65, and 66 exams. Some of the 12 WILEY SERIES 63 Exam Review 2016 more testable concepts relating to NASAA’s model rules and policy statements include the following: • Policy statement detailing dishonest and unethical business practices of broker dealers and agents • Policy statement relating to dishonest sales practices relating to the sale of investment company products by broker dealers and agents • Policy statement detailing requirements for broker dealers conducting business on the premises of other financial (banking) institutions • Model Rule covering unethical business practices of investment advisers • Model Rule detailing requirements for investment advisers who maintain custody of client funds THE UNIFORM PRUDENT INVESTORS ACT OF 1994 The Uniform Prudent Investors Act of 1994, or UPIA, sets the basic standards by which all investment professionals acting in a fiduciary capacity must abide. The UPIA updates the requirements and definitions of prudent standards in light of the application of modern portfolio theory and the advancement in the understanding of the behavior of capital markets. The UPIA laid out five fundamental changes in the approach to prudent investing for investment professionals acting in a fiduciary capacity. Those changes are: 1. The main consideration of a fiduciary is the management and trade off between risk and reward. 2. The standard of prudence for each investment will be viewed in relationship to the overall portfolio rather than as a standalone investment. 3. The rules regarding diversification have become part of the definition of prudent investing. 4. The restrictions from investing in various types of investments have been removed, and the trustee may invest in anything that is appropriate in light of the objectives of the trust and that is in line with other requirements of prudent investing. 5. The rules against delegating the duties of the trustee have been removed, and the trustee may now delegate investment functions subject to safeguards. CHAPTER 2 Definition of Terms INTRODUCTION In order to successfully complete the Series 63 exam, it is important to have an in-depth understanding of the terms used within the securities industry—specifically within the framework of the Uniform Securities Act. The terms used by the USA, also known as the Act, may have broader meanings than we are accustomed to in everyday usage. SECURITY A security is anything that can be exchanged for value that involves a risk to the holder. A security also represents an investment in an entity managed by a third party. The Howey test was used by the Supreme Court to determine whether something is a security. The test states that a security must meet the following four characteristics: 1. It must be an investment of money. 2. It must involve a common enterprise. 3. It must give the investor an expectation of a profit. 4. It must entail the management of a third party. The following are examples of securities: • Stocks • Bonds 14 WILEY SERIES 63 Exam Review 2016 • Notes • Debentures • Evidence of indebtedness • Transferable shares • Warrants, rights, or options for securities Most times when you see the term “certificate,” you have a security that is a: • Certificate of interest in profit sharing or a partnership agreement. • Preorganization certificate. • Collateral trust certificate. • Voting trust certificate. • Certificate of interest in oil or a gas mining title. • Certificate of deposit for a security, such as an American depositary receipt (ADR) or an American depositary share (ADS). The term “variable” will also identify a security, as in: • Variable annuity • Variable life insurance • Variable contract The phrase “interest in” is another key to identifying a security on the Series 63 exam. All of the following are securities: • Farmland and animals • Whiskey warehouse receipts • Commodity options (not futures) • Insurance company separate accounts • Real estate condominiums or cooperatives • Merchandise marketing programs, franchises, or schemes • Multilevel distributorships, such as Amway The term “option” is also a good way to identify a security, such as: • Stock option • Index option CHAPTER 2 Definition of Terms 15 • Futures option • Commodity futures option The following are not considered securities: • Real estate • Retirement plans, such as IRAs and 401(k)s • Bank accounts • Collectibles • Precious metals • Fixed annuities/fixed contracts • Whole and term life policies • Antiques • Futures contracts (commodities) • Trade confirmations • Prospectuses The term “future,” when it appears alone, is an indication that a security is not involved. However, if the question is asking about a commodity future option or a single stock future, then a security is involved. Also the term “fixed” is a good indication that a security is not involved. If a person commits a fraudulent act in the sale of an investment that is not deemed to be a security, then that person has not violated securities laws but rather has committed a fraudulent act in violation of other state and federal laws. PERSON The term “person,” as it is used in the USA, refers to any entity that may enter into a legally binding contract. Any entity that can enter into a legally binding contract may transact business in the securities markets. Agreeing to buy or sell a security represents a legally binding contract. For the Series 63, a person is any of the following: • Natural person