Series 7 – Units 11-17

Qualified vs Nonqualified Plans

 Both allow tax-deferred growth

Qualified Nonqualified
Contributions are tax deductible Contributions not tax deductible
Needs IRS approval Does not need IRS approval
Cannot discriminate Can discriminate
Tax on accumulation is deferred Tax on accumulation is deferred
All withdrawals taxed Excess over cost base taxed
Trust Not a trust
E.g.: IRA, TSA (non-profits), Keogh, Defined Benefit, E.g.: fixed/variable annuities, deferred comp and payroll
Coverdell/529, Defined Contribution (401k, profit share) deduction

 Not suitable: short sales, uncovered options, margin acct. transactions

Deferred Compensation Plan
 Money is not set aside; business failure can lead to no payment (retiree becomes a creditor of the firm)
 BoD cannot have this plan since they are not employees
 Employer is entitled to tax deduction when the benefit is paid out
Payroll Deduction Plans
 Employees authorize employer to deduct a specified amount for retirement savings
 NOT 401(k)
Individual Retirement Accounts (IRA)
 Annual contribution limit: $5,500 (<50 years) and $6,500 (>=50)
o Contributions are made from Earned Income (wages, salaries, bonuses, commissions, tips, alimony). Income from
investments don’t qualify
o If contributions are above limit, 6% penalty applied to the excess amount
o Individuals may contribute until age 70 ½
 Fully tax deductible only if
o Investor is ineligible to participate in any other plan
o AGI <$120 k (single) or $189 k (joint)  Roth
o AGI <$62 k (single) or $99 k (joint)  Traditional
 Contributions must be made before April 15 of the year following the tax year
 FDIC insurance on retirement accts held at banks is $250,000

Not Allowed Allowed

Collectibles Covered calls
Life Insurance / Cash Life Insurance U.S. mint gold/silver
Short sales Annuities
Speculative options (only covered calls)
Margin acct trading
Munis

 Distributions MAY begin at 59 ½ and MUST begin by April 1 of the year after he turns 70 ½
 Premature withdrawal: before 59 ½  10% penalty + taxed as regular income, except for:
st
o Death, disability, 1 home, education expenses, medical premiums for unemployed, medical expenses in excess of
AGI limit
 Insufficient distribution: if distribution does not begin by 70 ½ (required beginning date), a 50% penalty is applied to the amount
that should have been withdrawn according to IRS life expectancy table), “required minimum distribution”
 IRA Rollovers: cash and deposit within 60 calendar days. Can only be done once a year.
o If you change employer, you may get lump-sum payment and then deposit in IRA rollover account, where the
amount deposited retains its tax-deferred status
 Transfers: directly from one acct to another, unlimited number per year
 HSA: IRS allows a one-time funding distribution from IRA to a HAS w/o paying federal income tax or penalties

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 Series 7 – Units 11-17

Roth IRA
 Combined contributions to traditional and Roth must not exceed limit
 After-tax dollars contributed
 Tax-free withdrawals
o After funds in acct for 5 years and after 59 ½ years of age
 Required minimum distribution at age 70 ½ does not apply to Roth IRA

Coverdell (Education IRA)

 A-T contribution: Max $2,000 / year / child for children under 18
 Distributions are tax free as long as they are used for education (college, secondary, elementary)
o Income grows tax deferred
 If account is not depleted by age 30, the funds must be distributed to the individual subject to income tax + 10% penalty, or rolled
into another Coverdell from family member

Section 529 Plans

 A-T contribution: Max $15,000 / year / donor
o Can make 5 year upfront contribution
o Considered gifts under federal tax law
 Distributions tax free at federal level and state level if plan is in-state
o Up to $10,000/year can be used for education other than college/technical school (intended for post-secondary
school)
 Assets in the account remain under the donor’s control even after the student becomes of legal age
o Account balances may be transferred to a related beneficiary
 A rollover from one state plan to another is permitted once every 12 months

Simplified Employee Pensions (SEP IRAs)

 Self-employed and SMBs
 Employer can take an income tax deduction for contributions made each year to each employee’s SEP
 Not included un employee’s gross income

Keogh (HR-10) Plans

 Self-employed
 Defined Contribution: up to 25% of taxable income
 Defined Benefit: contributions must be calibrated to ensure that the plan will be able to provide for the benefit
 Contributions can be made up to age 70, like IRAs
 An employer making the max contribution to his plan must contribute 25% of employee salary to their Keogh. Eligible if:
o Has worked at least 1,000 hs in the year
o Completed >1 year of continuous employment
o At least 21 years of age
 Cash-value life insurance is allowed, while not in IRA
 Excess contribution: 10% penalty

Tax Sheltered Annuities 403(b) Plans

 Public schools and non-profits (501c)
 At least 21 yrs of age and 1 year of employment
 457  Congress

Corporate Plans (no short sales, uncovered options, margin transactions)

 Defined benefit
o Unfunded pension liability
 Defined contribution: contribution specified by trust agreement
o Profit sharing: based on corporate profits, no fixed contribution, can skip some year
o 401(k) – Money Purchase Plan: taxable when money is withdrawn, also permits hardship withdrawals. Employer can
match up to a %

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 Series 7 – Units 11-17

 Self-employed 401(k): no full-time employees, higher contribution limits, greater flexibility and penalty-free
loans from the plan.s funding
o Savings Incentive Match Plans for Employees (SIMPLEs): <100 employees, pre-tax match up to annual limit

ERISA
 Private sector (corporations) retirement plans and certain union plans (not gov. workers)
 Prevent abuse of pension funds
 Participation: all employees 21+ age with 1 year FT service (>1,000 hs)
 Segregation: assets segregated form other corporate assets
 Vesting: employees entitled to their benefit within a certain # of years of service, even if they leave
 Statements: annual and updates on plan benefits
 Nondiscrimination: all employees treated equal
 Beneficiaries must be named in case employee dies

Unit 12 – Variable Annuities

 Funded with A-T dollars, money grows tax-deferred, only earnings are taxed at distribution (ORDINARY income tax rate)  cost
basis is excluded as contribution was with A-T dollars
o There is no such thing as cap gain tax on retirement plans or annuities

Fixed Annuity Variable Annuity

Not a security (INSURANCE PRODUCT) Is a SECURITY
Payment made with after-tax dollars
Investment in a general account Investment in a separate account
Fixed-income and RE securities Equity, debt or MFs
Insurer assumes investment risk Annuitant assumes investment risk
Guaranteed rate of return Return depends on separate acct performance
Fixed administrative expenses
Income guaranteed for life
Monthly payment never falls below guaranteed min Monthly payments go up and down
Purchasing power risk Typically protects against Purchasing Power risk
Subject to insurance regulation Subject to registration with state insurance commission and SEC
 Prospectus!
Insurance license only Insurance and securities license

 Combination annuity  combination of both F.A. and V.A.

 Death benefit provision: beneficiary received greater of value in Separate Account or invested amount
o No penalty for early withdrawal even if the beneficiary is younger than 59 ½
o Payout taxable at ordinary income rate above cost basis
 Management and registration under Act of 1940
o Directly managed: Open-End mgmt. company
o Third party: UIT

MF VA
Sales Load 8½% No max
Pricing NAV calculated daily Unit value calculated daily
Share Value Depends on fund performance Depends on separate acct performance
Regulated by Act of 1933/1934, Inves. Company Act of ’40, Investment Advisers Act of ‘40
Voting Rights Investment policy and investment adviser voted by shareholders and investors
Main difference  Div. & cap. gains distributed and taxed  Div. & cap. gains not distributed and grow tax free
 No guarantee on income  Some guarantee on income
Upon Death  Estate  Beneficiary

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 Series 7 – Units 11-17

 Distribution are not paid to investors, they increase value of units in the separate acct
 If withdrawals are made before age 59 ½, a 10% penalty is applied to the earnings

Purchasing annuities
 Single premium deferred annuity: lump-sum to buy, payment of benefits delayed until later date
 Periodic payment deferred annuity: invested over time,
 Immediate annuity: lump-sum to buy, benefits commence within 30 days

$$$ IN $$$ OUT

ACCUMULATION PHASE ANNUITIZATION PHASE
Accumulation Units Annuity Units
# varies with additional purchase # fixed
Value depends on separate account performance

 Accumulation unit: accounting measure used to determine the contract’s owner interest in the separate acct.
 Assumed Interest Rate (AIR): conservative projection of the performance of the separate acct over estimated life of the contract.
Only relevant during annuity phase
 If a sep. acct. perf > AIR, monthly income is more than previous month’s payment

Purchasing annuities
 Life Income (life-only annuity): stops when annuitant dies, greater monthly payments
 Life Period Certain: guaranteed monthly income for life, if he dies before end of period, named beneficiary receives payments for
remainder of period
 Joint Life with Last Survivor: guarantees payment over 2 lives, smaller monthly payments
Other Specifications
 Guaranteed Minimum Withdrawal Benefits (GMWBs): until acct goes to zero, not lifetime
 Lifetime Withdrawal Benefit (LWB) or Lifetime Income: payment for life even if acct goes to zero, cannot withdraw early, not
suitable for someone that will have a short life

Withdrawals
1. Income  taxed at ordinary income
2. Cost basis  not tax
 10% penalty for early withdrawals (before 59 ½)

Suitability
 Suitable for those who can fund the contract with cash
 Not suitable for early withdrawal
 Do not belong in tax advantaged accounts (as IRA), but are not prohibited
 Not suitable for low risk tolerance or wary of stock market
 Best considered supplements to retirement income like IRA and 401(k)

Variable Life Insurance (VLI)

 Invest premiums in both general and separate acct
 Minimum guaranteed death benefit (gral acct), which may increase depending on separate acct performance
 Waiver of premium in case of disability

Variable universal life insurance (VUL)

 Separate account
 Investor assumes investment risk
 Presented as insurance product and not an investment
 Need both insurance and securities license to sell

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 Series 7 – Units 11-17

Unit 13 – Direct Participation Programs (DPPs)

 DDP is tax-reporting entity (entity does not pay taxes)
 Flow-through: Investors receive a share of all income/losses (form K-1) and pay taxes (no double taxation)
 Advantages: managed by others, limited liability, flow-through of income and certain expenses (and their tax)
 Disadvantage: lack of liquidity
o MLPs: trade OTC and exchanges
 DPPs are generally structured as Limited Partnerships or Subchapter S Corp.
 DPPs needs to avoid at least 2 of the 6 characteristics of a corporation:
o Associates
o Profit motive: always needed, cannot just be an abusive tax shelter. Economic viability should be #1 consideration
for an investor. Back taxes, penalties, prosecute for fraud
o Centralized mgmt.
o Limited liability
o Continuity of life  easiest to avoid, always have a term
o Freely transferable interests  easiest to avoid, transfer needs to be approved by GP
 Blind pool: >75%
Forming a Limited Partnership
 Requires at least one GP and one LP
 Private placement: PPM to accredited investors
 Public offering: prospectus
o Syndicator responsible for paperwork and gets 10% max fee
Required Docs
 Certificate of Limited Partnership: filed in the home state, update must be made within 30 days of the event
 Partnership Agreement: right of GP defined – mgmt. fee, authority to bind partnership into contracts, right to determine which
partners should be included in the partnership and right to determine whether cash distributions will be made
 Subsc. Agreement: LP net worth, LP annual income, understanding of risks, POA
 LPs are liable for a proportionate share of recourse loans assumed by the partnership
 LPs are not liable for nonrecourse loans (GPs are liable), except in RE partnerships

Dissolving a Limited Partnership

 May occur at end of fund life, if partnerships dissolves assets or if a majority of LPs decides
 Certificate of Limited Partnership is cancelled
 Account is settled in this order: Secured Lenders, Other Creditors, LPs, GPs

GPs LPs
Unlimited liability: personal liability for all partnership business Limited liability: can lose no more than their investment and
losses and debits proportionate interest in recourse notes
1% min GP commitment Vote on changes to investment objectives and new GP
Cannot borrow from partnership Inspects books and records

RE Partnerships
 Capital growth potential
 Cash flow (income)
 Tax deductions from mortgage interest expenses and depreciation allowances
 Tax credits for government-assisted housing and historic rehabilitation

Advantages Disadvantages
Raw Land Undeveloped land Appreciation only No income/tax deductions Most Speculative
New Construction Minimal maintenance Inability to deduct current Deductions for expenses
costs expenses during and depreciation after
construction period construction is completed
and income is generated
Existing Property Immediate CFs Greater maintenance / Deductions for mortgage
repair interest and depreciation
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 Series 7 – Units 11-17

Government- Low-income and Tax credits and rent Risk of change in regulation Tax credits and losses
Assisted Housing retirement housing subsidies
Historic Rehab Develop historic sites Tax credit and deductions
for commercial use for expenses and
depreciation

O&G Partnerships
 Intangible Drilling Costs (IDCs): drilling expenses 100% deductible in 1 year of operations (wages, supplies, fuel, insurance)
st

 Tangible Drilling Costs (TDCs): depreciated over several years

 Depletion Allowances: tax deductions to compensate for decreasing supply of O&G, taken only once O&G is sold

Exploratory (wildcatting) High IDCs – high risk/reward

Developmental (step outs) Medium IDC, immediate tax sheltering
Income Income sheltering from depletion allowances – Safest
Combination Exploratory + Income

 Overriding Royalty Interest: receives royalties, no partnership risk

 Working Interest: share income AND costs
 Reversionary Working Interest: LPs bear all costs and receive all their capital first before GP (which bears no costs)
 Net operating Interest: LPs bear all costs and GP receives a % of net profits.  Private Placement only
 Disproportionate Sharing: GP bears small % of costs and gets disproportionate share of revenues
 Carried Interest: LP/GP share tangible drilling costs, but LPs receives immediate deductions, whereas GP receives write-offs
 Functional Allocation (most common): LP receives IDCs, GP TDCs

Equipment Leasing Programs

 DPP purchases equipment leased to businesses (airplanes, railroad cards, computer, etc.)
o Risk of obsolescence
 Write-offs from operating expenses, interest and depreciation  tax-sheltered income

Tax
 PASSIVE LOSSES CAN BE ONLY USED TO OFFSET PASSIVE INCOME !  NO LIMITS!
 Depreciation can be straight line of accelerated (MACRS), which increases deductions in early years
 Crossover point: program begins to generate taxable income instead of losses
 Cost basis: calculated every year (cash and property contributions + recourse debt + nonrecourse of RE – distributions and
repayment of debt). Partners are allowed deductions up to the adj. cost basis amount (all else is carried forward)
 Depreciation recapture: if at the time of sale, depreciation deduction is in excess of what would have been taken had the
partnership been using straight line method, the difference is subject to ordinary income tax

Unit 14 – Direct Participation Programs (DPPs)

Business Cycles - EPCT
 Expansion, Peak, Contraction, Through: El Pato Come Taco
 Recession: > 6 months
 Depression: > 6 quarters
 Counter cyclical: precious metals
 Deflation: general decline in prices
 Stagnation: no growth + unemployment
 Stagflation: inflation + unemployment
Economic Indicators
 Leading: money supply (M2), building permits (housing starts), initial claims for unemployment, new orders for cons.
goods/machinery, changes in inventories, changes in sensitive materials prices, stock prices, changes in business and consumer
borrowing
 Coincident: hours worked, employment, personal income, industrial production, manufacturing and trade sales, GDP

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 Series 7 – Units 11-17

 Lagging: corporate profits, duration of unemployment, labor cost per unit of output, ratio of inventories to sales, commercial and
industrial loans outstanding, consumer installment credit to personal income, prime rates

Economic Theories
 Keynesian: demand-side economics, interventionist, fiscal policy (tax and government spending)
 Monetary/Friedman: regulate M2 (FRB)
o Reserve requirements (most drastic, has multiplier effect)
o Discount rate
o Open Market Operations (most frequent): Fed buys T-bills, money supply up, interest rates down  QE
 Supply-Side/Laffer: Laissez-faire

Fiscal Policy
 Congress/President – long Term solutions
 Federal spending
 Taxes
 Federal budget deficits or surpluses

Activity Fed M2 (Money Supply) Bond P Credit Condition Interest Rate

Repo (bank sells Fed buys ↑ ↑ Loosen ↓  Expands Economy
& agrees to buy  Increases inflation
later)  Bullish
Reverse Repo Fed sells ↓ ↓ Tighten ↑  Contracts economy
(bank buys &  Tames inflation
later sells)  Bearish

Technical Analysis
 Consolidation: trendline is horizontal
 Oversold: market index declining, but the # of declining stocks is fewer than advancing stocks, it will reverse itself
 Dow theory:
o Primary trends: 1+ years
o Secondary trends: 3-12 weeks  higher highs and lower lows
o ST fluctuations: hours or days
 Odd-Lot Theory: small investors are wrong
 Short Interest Theory: higher shorts, bearish market
 Modern Portfolio Theory: securities markets are efficient
 Random Walk and Efficient Market Theory: direction of market is unpredictable

Indexes
 DJIA: oldest and most widely quoted index
 Dow Jones composite: 30 industrial, 20 transportation and 15 utilities  narrowest
 Value Line: 1,700 NYSE and OTC stocks
 Wilshire 5000: all NYSE listed stocks and Nasdaq  broadest
 S&P 500

Fundamental Analysis
 Defensive: food, pharma, tobacco
 Cyclical: durable goods, machinery, raw material, automobiles
 Growth: retain earnings for R&D, little to no dividends
Balance Sheet
 Current assets: can be converted into cash in 12 months
o Cash, accts receivables, inventory and prepaid expenses
 Current liabilities: due in 12 months
o Accts/notes payable, accrued wages payable, current LT debt, accrued taxes
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 Series 7 – Units 11-17

 Capitalization = LT debt + equity

 Dividends: declaration of cash dividends established a current liability until it is paid
o Stock dividends/splits has no effect on assets or liabilities. Just affects par value per share and shares outstanding
 FRB defines industrial companies with Debt-to-Equity >50% as highly levered

BDC
 Set up as Closed-End Investment Companies
 Private BDCs are illiquid, subject to share repurchases below NAV

Ratios
 Debt-to-Equity = LT Debt / total Sh equity
 Bond Ratio = LT liabilities / total capitalization
 Common stock ratio = common shareholder equity / total capitalization
 Preferred stock ratio = preferred stock / total capitalization
 Current ratio = current assets / current liabilities
 Quick assets = current assets – inventory
 Quick ratio (acid-test) = quick assets / current liabilities
 Cash asset ratio = cash and equivalents / current liabilities
 DSCR = EBIT / (annual interest + ppal)
 BV / share = (assets – liabilities – intangibles (incl goodwill) – par value of preferred stock) / common stock outstanding
 BV / share = ( net worth – intangibles (incl goodwill) – par value of preferred stock) / common stock outstanding
 Disintermediation: flow of bank deposits to higher-paying investments. Occurs when money is tight and interests are high

Unit 15 – Ethics, Recommendation and Taxation

 Conduct Rules: ethical treatment of customers
 A ppal must review and approve all correspondence and keep a record of all securities transactions and correspondence
 Member firms must periodically review all branch office activities to detect and discipline individual who engage in unethical
behavior
 It is the customer’s responsibility to provide full and honest disclosure to his RR or investment adviser
 All B/D are required to maintain written supervisory procedures
o A ppal is responsible for enforcing
 Statue of limitations of Act of 1934: 3 years from manipulation and within 1 year of discovering it. No dollar limit on lawsuit
 Outside business activity (OBA): need to provide prior written notice to member, who has the right to restrict any outside affiliation
if there is any conflict of interest. Passive investment, as limited partnership, not considered outside business activity
 Private Securities Transactions (selling away): sale of securities outside regular business with member/employer. Must notify
employer
o With comp: employing member may disapprove/approve. If approved, it has to be entered in its own books
o Without comp: acknowledge written notification, immediate family excluded
 Paying for referrals (finders fee): prohibited
 Excessive trading: churning
o Reverse churning: placing clients who trade infrequently in fee-based accts
 Influencing employees of other firms: compensation not conditional on sales, employing member’s prior approval, total value
below $100 per year, gift is associated with a life event (bereavement, wedding, child)
o Noncash expenses (dinners, seminars, entertainment) can exceed $100
o Vacations and season tickets are always violations
 Borrowing and lending: allowed
o Immediate family relationship – no notice/approval
o Customer is in the business of lending money – no approval
o Both registered persons with the same firm – need notice/approval
o Personal/business relationship outside broker-customer relationship – need notice/approval
 Research reports – do not present as your own
o Soft dollar arrangements: using client money to direct transactions to a B/D in exchange for research. Disclose
o Safe Harbor Rule for Soft Dollar Arrangements (Act of ’34): provides assistance in investment decision making,
reasonable commission, specific services (research, newsletters, analytical software, seminars)
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 Series 7 – Units 11-17

 Sharing Customer Accounts

o Joint acct for immediate family – permitted, no need to be pro rata
o RR with a client – needs approval and is pro rata
Other Prohibited Practices
 Painting the tape: selling and buying same day at same price
 Marking the close: effecting trades or falsely reporting trades to influence closing price
 Front running: putting an order before a block order (10,000+ shares)
 Interpositioning: adding another B/D when there is no benefit to the buyer/seller
 A RR may file a tip with FINRA via the Regulatory Tip Line in Washington, DC

Suitability
 KYC: does not apply if the recipient is not a client and neither the RR/firm receives direct/indirect comp for advise
 Capital Preservation: government securities, not so much corporate (equities in particular)
 Current Income
o Monthly income: variable annuities or GNMA
o Safety: cash, MM, CDs, Gov securities, bank-grade corporate and munis, blue-chip stock/bond MF
o Growth: growth and small-cap stock, stock options, HY bonds, grow-oriented LPs, growth stock MF, commodities
funds and variable annuities
o Speculation: low-rated debt securities, precious metals, commodities and futures
Risks
 Unsuitable trades: tag the ticket unsolicited and have client sign a statement acknowledging that the rep advised against it
 Timing risk: risk an investor buys/sells at the wrong time
 Interest rate risk: LT maturities, low coupons, lower price are most susceptible
 Reinvestment risk: mortgage-backed instruments are most susceptible, zero-coupon bonds are not subject
 Call risk: call protection is a period when bonds cannot be called
 Market risk/systematic risk
 Credit/financial/default risk
 Liquidity: munis have regional markets, so may have less liquidity
 Alpha: return above benchmark
 Beta: measures systemic/systematic risk. Beta of 1.5 means a 10% increase in S&P makes stock rise 15%

Portfolio management
 Geographic diversification is only relevant for munis
 Dollar cost averaging: periodic purchase of a fixed dollar amount
 Constant ratio plan: always set ratio (40% bond, 60% equity)
 Constant dollar plan: a set dollar amount remains invested at all times. Invests more when markets are down
 Strategic asset allocation: 30-year old invests 30% in bonds and 70% in stock
 Tactical Asset Allocation: considers current market conditions
 Growth: buy stocks at 52-week high
 Value: buys stock at 52-week bottom

Taxes
 Regressive: impact lower-income more than higher-income people, like sales taxes
 Progressive: the opposite, like income tax
 Types of income
o Earned (active) income: salary, bonus, etc
o Passive: rental property, limited partnership, enterprises where one is not actively involved
 Passive losses may be used to offset passive income only
 ST capital gains have a holding period <12 months and taxes as ordinary income
o IF CAPITAL LOSSES EXCEED CAPITAL GAINS, A TAXPAYER CAN USE UP TO $3,000 TO OFFSET ORDINARY INCOME AND
CARRY FORWARD ANY UNUSED AMOUNT
 Current year had $12 k loss and $5 k gains, of the $7 net cap loss, $3 are used to offset ordinary income
and the rest is carried forward
 Accrued interest is taxable income to the seller
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 Series 7 – Units 11-17

 Qualified dividends: investment held for more than 60 days during a 121-day period that begins 60 days before ex-date
 MF distributions are taxable during the year of distribution
 Cash dividends/interest: TAXABLE UPON RECEIPT
 Stock dividend/split: not taxable, reduce cost basis
 Cost basis and proceeds includes commissions
 FIFO, share identification, average basis
o Share identif: must be done before settlement
 Wash Sales: identical security bought/sold 30 days before / after
o Investor sells a security to realize a loss and then purchases the same identical one before/after trade date
o Options, rights, warrants, converts are considered the same stock
o Cost basis of reacquired security is adjusted by the disallowed amount
o Applies only to realized losses, not gains
o Can be prevented by buying different issuer, coupon, maturity

Taxation of Bonds
Corporate Muni
OID Discount MUST accrete MUST accrete (tax-free interest)
OID Premium May amortize MUST amortize
Secondary Discount May accrete May accrete – if bond is not accreted, the
difference between purchase price and
selling price is as a capital gain.
Secondary Premium May amortize MUST amortize

 Amortization reduces cost basis and reported interest income

 Accretion increase cost basis and increases reported interest income
 Premium Muni (OID & secondary) must be amortized straight line
o If held to maturity, no capital loss
o Because interest is not taxed, the annual amortization has no effect
 Discount Muni bond
o Secondary market: effective After-Tax yield is between YTM and coupon
 Accrued interest has no effect  Fixed to the seller

Donations & Inheritance

 Charitable donation: tax deduction for donor at market value. Cost basis for recipient is market value
 Donation to others: no tax deduction. Cost basis for recipient is original cost basis
 Inherited securities: cost basis is CMV on death day

Estate & Gift Tax  progressive, increase with gift size

 Estate: valuation at death
 Gift: date it is given
o Inter-spousal gifts are not subject to tax
o If a tax is due, it is paid by donor

 Margin interest: tax deductible, except for muni

o If banks purchase bank-qualified munis (small GO of <$10 mm), the bank may deduct 80% of the cost of financing
 Shorting against the box: lock in a capital gain that was going to happen later
o 5% margin requirement applies to proceeds from selling short against the box. The firm may release 95% of sales
proceeds to the customer
o The law now only allows the tax deferral if the short position is closed within 30 days of year end and the customer
stays long for an additional 60 days
o Shorting against the box cannot be used to stretch a ST gain into LT
 AMT: taxpayers are required to add the excess AMT over the regular tax to their regular tax to determine their tax liability
 Dividends paid from one corporation to another are 50% except from taxation. Tax is only paid for 50% of the dividends
 Income bonds: pays interest only if the corporation meets targeted earnings level
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 Series 7 – Units 11-17

Unit 16 – U.S. Government and State Regulations

 The Act of 1934 (People Act) is associated with: secondary market, outstanding securities, trading securities
o Tender offer: customer can only tender net long position
o Customers may not borrow stock in order to tender the borrowed stock
 Maloney Act of 1938: enabled SEC to create SROs or DEAs (Designated Examining Authorities), FIRNA, MSRB
 Trust Indenture Act of 1939: promise between issuer and trustee, for the benefit of bondholders. It applies to corporate bonds
with:
o Issue size >$50 mm within 12 months
o Maturity of 9+ month
o Offered interstate
 Investment Company Act of 1940: requires
o Registering with SEC
o State investment objective
o Have net worth at least $100,000 before offering to the public
o Owned by min 100 investors
 Investment Adviser Act of 1940: investment advice for compensation must register as investment advisor
 SIPC: protects against B/D failure/insolvency/liquidation. $500 k in separate customer accounts (same type of accounts are
combined), including max $250 k in cash
o SIPC is an independent gov sponsored corporation
o All B/D registered with SEC must be SIPC member, except those only handling MF/UIT and V.A./insurance
o Commodities and commodities futures are not protected by SIPC
o Customers with excess of coverage become general creditors
o Must say that additional info about SIPC may be obtained from SIPC. At account opening and then repeat every year
o Valuation: day customer protection proceedings begin = day court is petitioned to appoint a SIPC trustee
o Does not protect against fraud, bad investment
o Margin accounts, equity is covered
 Securities Act Amendments of 1975
o Created MSRB
 Insider Trading and Securities Fraud Enforcement Act
o Specifies penalties for insider trading and securities fraud
o Insider: anyone who has or passes on info not yet known to the public
o Penalty: inflation linked amount or 3x profit made or loss avoided (treble), whichever is greater
o Criminal penalties of up to $5 mm and 20 years in jail
o B/D firm: treble damages or $25 mm, whatever is greater
o Contemporaneous traders: may sue those who trade with inside information, suits may be initiated up to 5 year the
violation has occurred
o Informer bounty: 10-30% of amount recovered
o Giving out insider info, although imprudent, is not a violation. It becomes a violation when it is used to trade for a
profit or avoid a loss. Both tiper and tipee are liable
 Cold calling rules
o Penny stock: OTC non-Nasdaq <$5 price, highly speculative
o Customer must sign and date suitability statement before trading penny stock
o Established customer: held an account with the broker-dealer for at least one year; or made at least 3 penny stock
purchases of different issuers in different dates
o Provisions apply only to solicited transactions, transactions not recommended are exempt
 Bank Secrecy Act
o Placement: into laundering system
o Layering: conceal funds
o Integration:
o SAR (Suspicious Activity Report): filed by B/D for “financial behavior which is commercially illogical and serves no
apparent purpose” - $5,000 threshold
 Structuring: deposits below $10,000 cash transaction report (CRT) filing threshold

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 Series 7 – Units 11-17

 Regulation NMS (National Market System):

o Order Protection Rule: use best price
o Limit Up/Limit Down: limits double close to opening and closing
o Minimum Increment Pricing Rule (sub-penny):

State Securities Regulations

 Uniform Securities Act (USA) B/D with an office in the state or that direct/receive calls into/from a state need to be registered in
that state. Registrations are renewed annually.
o Isolated unsolicited transactions are exempt from registration requirement
 Blue-sky / register securities:
o Coordination (only for IPO): file simultaneously with state and SEC, become effective with federal filing
o Filing (Notification): issuer has met various financial criteria and has previously filed in a state, it can provide a notice
and will become effectively registered after the fifth business date of filing if no response
o Qualification: issuer must meet any requirement from state, effective only when state orsers, most difficult
registration

Unit 17 – Other SEC and SRO Rules & Regulations

 B/D must apply and be approved for registration with SEC
 If a B/D bars an associated person, he cannot associate with anyone else without the Commission’s permission
 If a member suspends a person, they must notify exchanges where the firm is a member
 Fingerprints: all directors, officers and partners must submit to U.S. A.G.
o Exempt from registration: people not involved in securities sales, do not handle/have access to cash/securities or
books/records (ministerial/clerical) and do not supervise other employees
SROs
 SROs are under SEC oversight
 FINRA: investment banking (underwriting), trading in OTC market/NYSE, investment companies and Limited Partnerships,
 MSRB: no enforcement power
 CBOE: trading standardized options

FINRA Manual
 Conduct Rules: Ethics and Fair Practices
 Uniform Practice code (UPC): guidelines to follow, modus operandi
 Code of Procedure: how violations to Conduct Rules are handled
o Investigate trade practice violations. FINRA transfers it to Department of Enforcement
o Usually uncovered in audit or complaint
st nd
o Accused has 25 days to reply to 1 notice and 14 days to respond to 2 notice
 If he does not reply: Summary judgment if he does not reply
 If he replies: Hearing is held within 21 days of response (panel is from industry). Decision rendered within 60
days of hearing  appeal must be made within 25 days
 Bar/expulsion is effective as of decision date, all else needs 30 day notice
o B/D must keep a records of customer complaint for 4 years
o Both RR and supervisor get charged
 Appeals: Department of Enforcement Hearing  National Adjudicatory Council  SEC  Federal Appeals (Supreme) Court
o AWC (acceptance, waiver and consent): does not admit or deny, settlement agreement signed, no appeal allowed
o Minor rule violation (MRV): max fine $2,500, censure and if accepted by respondent, no appeals. Not disclose in U4
 Code of Arbitration: how disputes between members, RR and the public is handled
o 45 days to respond to claim to Department of Arbitration AND Claimant
o If he does not reply, will be one-sided arbitration
o A member cannot force a customer into arbitration
 Mediation – not mandatory, if all parties agrees, occurs prior to arbitration (can be escalated to arbitration if no agreement is
reached)
o A mediator from FINRA tries to get to an amicable settlement
o Mediator may not serve on arbitration panel
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 Series 7 – Units 11-17

 Arbitration
o Simplified Arbitration: <$50,000
 One arbitrator (from public, if public is involved)
 Written arguments and decisions
 30 business day decision
o Larger disputes: $50,000-100,000 one arbitrator (unless both parties agree to 3) and >$100,000 three arbitrator
(unless both parties agree to 1)
 If >$100,000 public customer, they can request all three arbitrators be public
o Award has to be paid within 30 days of decision
o No appeal
o Statute of limitation: 6 years
 Pre-dispute arbitration agreement: easy to read, delivery and acknowledgment, member must supply a copy within 10 days of
request
 Non-public arbitrator: someone who worked in the financial industry, lawyer have a 5-year cooling off period to become
public arbitrators
 Any B/D registered with SEC is eligible and may apply for membership with FINRA
 Home office: needs to be approved by FINRA as any other office

Communications
 Retail communication: >25 retail investors within 30 days, needs pre-approval from a principal
o Do not need pre-approval: forum or does NOT make any financial or investment recommendation
 Correspondence: <=25 retail investors within 30 days, pre or post-review by a principal
 Institutional: B/D, gov entities, any entity >$50 mm
 Recordkeeping: retail communications kept for 3 years from last use, 2 years readily accessible
 Filing requirement with FINRA:
st
o During 1 year in business: Pre-filing - at least 10 business days prior to use
o After 1 year (established): Post-filing - within 10 business days of first use
o For a ranking: 10 bsuienss days before first use

Continuing Education
 Regulatory Element: computer based training program within 120 days of the 2nd anniversary of their registration approval date
and every 3 years thereafter
o Compliance, regulatory, ethical, and sales practice standards. Industry rules and regulations, widely accepted
standards and practices within the industry
o Principals, Series 6, 7, and 99 representatives
 Firm element: annual basis
 Annual Compliance Review: endure personnel attend the meeting and have opportunity to ask questions
 Personnel changing firms have 2 years to re-affiliate, based on initial filing date
o Terminate registration with U5 and re-apply with U4

 Continuing commissions: pay only commissions on business placed while employed (must have a contract in effect before leaving).
Retired and deceased get this if that document is in place
 Termination: must notify FIRNA within 30 days
o Members may not terminate someone under investigation
 RR: includes anyone who supervises, solicits or conducts business in securities and trains people
 Registered Principals: manages or supervises any part of a member’s IB or securities business. All member firms must have at least
2 reg. ppals (unless it is a sole proprietorships), need to take Series 24
 Statutory disqualification: disciplinary sanctions by SEC, another SRO, a foreign financial regulator or foreign equivalent of an SRO
o Misstatement willfully made, felony conviction or misdemeanor conviction involving securities or money within the
past 10 years and court injunctions

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