Series 24 — General Securities Principal — All Questions

Under FINRA Rule 3110, a broker-dealer's supervisory system must, at a minimum, include:

• a.A guarantee that no rule violations will ever occur
• b.Written supervisory procedures and the designation of qualified principals to carry them out✓
• c.Daily approval of every trade by the firm's CEO
• d.Approval of the firm's business plan by the SEC

Rule 3110 requires a supervisory system reasonably designed to achieve compliance, including written supervisory procedures (WSPs) and designated, appropriately registered principals. A system cannot guarantee zero violations, and there is no requirement for CEO approval of every trade or SEC approval of the business plan.

The SEC's net capital rule (Rule 15c3-1) is primarily designed to ensure that a broker-dealer:

• a.Earns a minimum level of annual profit
• b.Charges customers uniform commission rates
• c.Maintains enough liquid assets to wind down without harming customers✓
• d.Holds all customer securities in physical certificate form

The net capital rule requires a firm to keep minimum net liquid assets so that, if it fails, it can meet obligations and liquidate in an orderly way without loss to customers. It does not mandate profits, set commission rates, or require physical certificates.

The SEC customer protection rule (Rule 15c3-3) requires a firm to safeguard customer assets primarily through:

• a.The reserve formula and possession-or-control requirements for customer cash and fully paid securities✓
• b.Purchasing insurance from a private carrier for each account
• c.Holding all customer funds in the firm's operating account
• d.Reporting each customer's tax basis to the IRS

Rule 15c3-3 protects customers by requiring firms to maintain a special reserve bank account under the reserve formula and to keep fully paid and excess-margin securities in the firm's possession or control. Commingling customer funds with firm operating funds would violate the rule.

Under FINRA Rule 2210, a retail communication that promotes a specific investment product must generally be:

• a.Filed with the SEC before first use in all cases
• b.Sent only to institutional investors
• c.Kept confidential and never retained
• d.Approved by a principal before it is used or filed✓

Retail communications generally require principal approval before first use (or filing). They must be fair, balanced, and not misleading, and firms must keep records of them. Institutional communications and certain correspondence have different, lighter requirements.

Under FINRA Rule 3310, a firm's anti-money-laundering program must be:

• a.Approved by FINRA staff before adoption
• b.Approved in writing by a member of senior management✓
• c.Reviewed only when a customer is suspected of a crime
• d.Limited to accounts of foreign nationals

Rule 3310 requires the AML program to be approved in writing by senior management and to include a designated AML officer, a customer identification program, ongoing monitoring, independent testing, and SAR filing. It applies to the firm's business generally, not only to foreign accounts.

SEC Rules 17a-3 and 17a-4 require that certain electronic records be preserved:

• a.In any editable format the firm prefers
• b.For no more than 90 days
• c.In a non-rewriteable, non-erasable (WORM) format for the required retention period✓
• d.Only at the firm's clearing bank

Rules 17a-3 and 17a-4 dictate which records must be made and how long they must be kept, and they require electronic records to be stored in a non-rewriteable, non-erasable (WORM) format so they cannot be altered. Retention periods commonly run three to six years.

A principal reviewing the firm's compliance program discovers the WSPs have not been updated after a major rule change. The most appropriate action is to:

• a.Revise the written supervisory procedures to reflect the new rule and document the change✓
• b.Wait until the next annual cycle to make any changes
• c.Delete the outdated procedures without replacement
• d.Refer the matter to the SEC for approval before acting

Supervisory procedures must be kept current so the system remains reasonably designed to achieve compliance. When rules change, the principal should promptly amend the WSPs and document the update rather than waiting or leaving a gap.

When making a recommendation to a retail customer, an associated person must comply with Regulation Best Interest, which requires the firm to:

• a.Recommend the product that generates the highest commission
• b.Act in the customer's best interest and not place its own interests ahead of the customer's✓
• c.Guarantee the recommended security will not lose value
• d.Obtain written SEC approval of the recommendation

Regulation Best Interest requires broker-dealers to act in the retail customer's best interest at the time of a recommendation and not to put firm or representative interests ahead of the customer's, satisfying disclosure, care, conflict, and compliance obligations. It does not guarantee performance.

FINRA Rule 2090, the Know Your Customer rule, requires a firm to use reasonable diligence to:

• a.Predict the future performance of the customer's investments
• b.Match every customer to the firm's most profitable products
• c.Know the essential facts about each customer and the authority of persons acting on the account✓
• d.Guarantee the customer a minimum rate of return

The Know Your Customer rule requires firms to know and retain the essential facts about each customer needed to service the account and to understand the authority of anyone acting on the customer's behalf. It is about diligence, not performance guarantees.

A principal notices an account with frequent in-and-out trading that appears designed to generate commissions rather than benefit the customer. This is a red flag for:

• a.Churning (excessive trading)✓
• b.Best execution
• c.Regulation T compliance
• d.Freeriding in a cash account

Excessive trading intended to generate commissions rather than serve the customer's objectives is churning, an unsuitable and prohibited practice. A principal must supervise for it. Best execution and Regulation T address different issues.

The initial margin requirement for a purchase of marginable securities is set by:

• a.FINRA maintenance margin rules
• b.The individual broker-dealer only
• c.The SEC net capital rule
• d.Regulation T of the Federal Reserve Board✓

Regulation T, issued by the Federal Reserve Board, governs the initial extension of credit and sets the initial margin requirement. FINRA sets minimum maintenance margin, and firms may impose stricter house requirements.

Most disputes between a customer and a member firm are resolved through:

• a.A jury trial in federal district court
• b.FINRA arbitration✓
• c.A hearing before the SEC commissioners
• d.Binding mediation by the Federal Reserve

Customer agreements typically require that disputes be resolved through FINRA's arbitration forum, with mediation available. This provides a faster, industry-specific process rather than court litigation.

Under FINRA Rule 5310, a firm handling a customer order must use reasonable diligence to:

• a.Obtain the best execution, seeking the most favorable price under prevailing conditions✓
• b.Execute the order only on the firm's own trading desk
• c.Delay the order until the end of the trading day
• d.Match the order against the firm's proprietary position first

The best execution rule requires firms to use reasonable diligence to obtain the most favorable terms reasonably available for a customer order. Firms must conduct regular and rigorous reviews of execution quality and may not simply route to their own desk if better prices exist elsewhere.

A market maker in an equity security is obligated to:

• a.Buy shares only when the price is rising
• b.Guarantee customers a profit on every trade
• c.Publish firm two-sided quotations and stand ready to buy and sell✓
• d.Report trades once per week

A market maker holds itself out as continuously willing to buy and sell and must display firm two-sided (bid and ask) quotations. This provides liquidity and continuous pricing. Trades must be reported promptly, generally within a short time after execution.

The Manning rule generally prohibits a firm from:

• a.Charging any markup on a principal trade
• b.Making a market in more than one security
• c.Displaying a customer limit order to the public
• d.Trading ahead of a customer limit order for its own account without filling the customer at the same or better price✓

The Manning rule protects customer limit orders: a firm may not trade for its own account at a price that would satisfy the customer's limit order without also executing that customer order at the same or a better price. This prevents the firm from profiting at the customer's expense.

Entering matched orders to create the false appearance of active trading in a security is:

• a.A permitted market-making technique
• b.A manipulative practice prohibited under the Securities Exchange Act✓
• c.Required by Regulation M during a distribution
• d.Allowed if disclosed to customers afterward

Wash trades and matched orders that fabricate the appearance of trading activity are manipulative and prohibited under the Securities Exchange Act and Rule 10b-5. They deceive other market participants and cannot be cured by later disclosure.

During the cooling-off period of a registered public offering, which document may be distributed to prospective investors?

• a.A final prospectus with the effective price
• b.A confirmation of sale
• c.A preliminary prospectus (red herring)✓
• d.A research report recommending the issuer

During the cooling-off period only a preliminary prospectus, or red herring, may be circulated to gauge interest; it omits the final price and states that the registration is not yet effective. No sales may be finalized until the registration is effective.

In a firm-commitment underwriting, the underwriting syndicate:

• a.Buys the entire issue from the issuer and bears the risk of reselling it✓
• b.Acts only as the issuer's agent with no financial risk
• c.Guarantees the price of the stock after it begins trading
• d.Is prohibited from earning any compensation

In a firm-commitment deal, the syndicate purchases the whole issue from the issuer and assumes the risk of reselling it to the public. In a best-efforts arrangement, underwriters act only as agents and bear no purchase risk.

FINRA Rule 5130 generally restricts the sale of new equity IPO shares to:

• a.All individual retail customers
• b.Institutional investors only
• c.Foreign investors
• d.Restricted persons such as industry insiders and their immediate family✓

Rule 5130 prohibits selling shares of a new equity IPO to restricted persons, including broker-dealers and their associated persons and certain immediate family members, so that industry insiders cannot exploit access to hot new issues at the expense of the public.

Under FINRA Rule 2241, to protect research analyst objectivity, investment banking personnel are prohibited from:

• a.Reading any published research report
• b.Supervising analysts or controlling their compensation for specific transactions✓
• c.Attending any meeting where research is discussed
• d.Communicating with the issuer at any time

Rule 2241 separates research from investment banking so that banking cannot supervise analysts or tie their pay to specific deals, and analysts cannot promise favorable coverage to win business. This preserves the independence and integrity of research.

Regulation M is primarily intended to:

• a.Require registration of all private placements
• b.Set the initial margin requirement for new issues
• c.Prevent distribution participants from artificially supporting a security's price during its distribution✓
• d.Limit the compensation paid to research analysts

Regulation M restricts issuers, underwriters, and other distribution participants from bidding for or purchasing the security being distributed, preventing them from propping up its market price during the offering. It is an anti-manipulation rule for distributions.

When a registered representative's employment with a member firm ends, the firm must file a Form U5:

• a.Within 5 business days and only if the person was terminated for cause
• b.Within 30 days, stating the reason for termination truthfully✓
• c.Only if the representative requests it
• d.Within one year of the departure

The firm must file Form U5 within 30 days of an associated person's termination, giving a truthful reason for the departure, and must amend it if new information later comes to light. Form U4 is the corresponding registration filing that must be kept current.