FINRA Series 6 — All Questions

How is the net asset value (NAV) per share of an open-end investment company calculated?

• a.Total assets minus total liabilities, divided by the number of shares outstanding✓
• b.The market price of the fund's shares at the close of trading on the exchange
• c.Total assets divided by the number of shares outstanding
• d.Total assets minus total liabilities, divided by the number of shareholders of record

NAV per share is the fund's net worth (assets less liabilities) spread over the shares outstanding, computed at least once each business day. Ignoring liabilities overstates value, so the first choice is wrong. Open-end fund shares do not trade on an exchange at a market price, and dividing by shareholders rather than shares produces a meaningless figure.Investment Company Act of 1940

A customer calls at 11:00 a.m. and places an order to buy shares of a mutual fund that prices its portfolio once daily at the close of the market. Which price will the customer receive?

• a.The next NAV computed after the order was received✓
• b.The NAV computed at the close of the previous business day
• c.The NAV in effect at the moment the order was accepted
• d.The average of the previous day's and the current day's NAV

Forward pricing requires that purchase and redemption orders be executed at the next price calculated after the order is received, which here is that day's closing NAV plus any sales charge. Using the prior day's price or an intraday value would let investors trade on stale information. Averaging two days' prices is not a pricing method any fund uses.Investment Company Act of 1940

A mutual fund has a net asset value of $9.30 per share and a sales charge of 7% of the public offering price. What is the public offering price?

• a.$10.00✓
• b.$10.65
• c.$9.95
• d.$10.35

POP equals NAV divided by (100% minus the sales charge percentage), so $9.30 / 0.93 = $10.00. Adding 7% to the NAV gives $9.95, a common error because the sales charge is a percentage of the offering price, not of NAV. The other figures reflect sales charges well above the 7% stated.

A fund's public offering price is $12.50 and its net asset value is $11.50. What is the sales charge percentage?

• a.9.3%
• b.8.7%
• c.7.5%
• d.8.0%✓

The sales charge equals the dollar spread divided by the public offering price: $1.00 / $12.50 = 8%. Dividing the $1.00 by the NAV instead produces 8.7%, which is the classic trap because the sales charge is always stated as a percentage of POP. The remaining figures do not correspond to either calculation.

Under FINRA rules, an open-end fund may impose the maximum permitted sales charge of 8.5% only if it offers which combination of features?

• a.Breakpoints and a letter of intent, but no rights of accumulation
• b.Breakpoints, rights of accumulation, and reinvestment of dividends at net asset value✓
• c.Rights of accumulation, a letter of intent, and reinvestment of dividends at net asset value, but no breakpoints
• d.A letter of intent, an exchange privilege, and a conversion feature, with no breakpoints or rights of accumulation

FINRA Rule 2341(d)(1) allows an 8.5% maximum sales charge only if the fund also gives investors quantity discounts (breakpoints) and rights of accumulation, and the rule separately bars a sales charge on reinvested dividends, so reinvestment at net asset value is part of the package. A fund without favorable rights of accumulation is capped at 8.0%, and one without favorable quantity discounts is capped lower still. A letter of intent, an exchange privilege and a conversion feature are optional features, not conditions of the maximum.FINRA Rule 2341(d)(1)

A customer wants to invest $24,000 in a fund whose next breakpoint occurs at $25,000. The representative processes the $24,000 order without mentioning the breakpoint. This conduct is best described as:

• a.Breakpoint selling, which is prohibited✓
• b.Switching, which requires principal approval
• c.Acceptable, because breakpoints apply only to purchases above $50,000
• d.Acceptable, because the customer named the dollar amount

Selling shares in an amount just below a breakpoint without disclosing that a slightly larger purchase would reduce the sales charge is breakpoint selling, a prohibited practice that benefits the representative at the customer's expense. The customer naming the amount does not relieve the representative of the duty to disclose. Breakpoint schedules commonly start well below $50,000, and switching refers to moving assets between funds, not to a single new purchase.FINRA Rule 2341 (Investment Company Securities)

Which statement about a letter of intent (LOI) for mutual fund breakpoints is correct?

• a.It is a binding contract requiring the investor to complete the purchases on penalty of forfeiting the discount
• b.It covers 13 months and may be backdated up to 90 days to include a prior purchase✓
• c.It permits the investor to count purchases made in any other fund family toward reaching the breakpoint discount
• d.It covers a period of 24 months and cannot be backdated

An LOI lets an investor obtain a reduced sales charge by pledging to invest a stated amount within 13 months, and it may be backdated as much as 90 days so a recent purchase counts toward the goal. The letter is not binding: if the investor does not complete it, the fund simply liquidates escrowed shares to collect the higher sales charge. Purchases in unrelated fund families do not count toward the LOI.FINRA Rule 2341 (Investment Company Securities)

Rights of accumulation differ from a letter of intent in that rights of accumulation:

• a.Give a fixed discount on every purchase, whatever the investor already holds
• b.Count only purchases made within the past 13 months, ignoring any older holdings
• c.Require the investor to commit to future purchases within a stated period to keep the reduced sales charge
• d.Have no time limit and let existing holdings count toward the next breakpoint✓

Rights of accumulation allow the current value or total cost of shares already owned to be added to a new purchase so the combined amount reaches a breakpoint, and there is no deadline for using them. A letter of intent, by contrast, looks forward over a stated period, typically 13 months, and requires a commitment to future purchases. Rights of accumulation do not give a flat discount unrelated to holdings, and they are not limited to the past 13 months.FINRA Rule 2341(d)(1)(B)

A 12b-1 fee charged by a mutual fund is used primarily to pay for:

• a.Brokerage commissions paid when the portfolio manager buys and sells securities
• b.Distribution and shareholder servicing costs, such as marketing and compensation to selling firms✓
• c.The investment adviser's management fee for selecting the fund's securities
• d.Custodian and transfer agent fees for safekeeping assets and keeping shareholder records

Rule 12b-1 under the Investment Company Act of 1940 permits a fund to use fund assets to pay for distribution and shareholder servicing, such as marketing and compensation to selling firms, and the fee is deducted from assets annually rather than charged at the point of sale. Portfolio brokerage commissions, the advisory fee, and custodian and transfer agent fees are separate expenses disclosed in the prospectus.17 CFR 270.12b-1

A fund may describe itself as "no-load" only if its annual 12b-1 charges do not exceed:

• a.There is no limit, because no-load refers only to the absence of a front-end charge
• b.0.75% of average net assets
• c.0.25% of average net assets✓
• d.1.00% of average net assets

FINRA permits the no-load label only when combined asset-based sales and service charges stay at or below 0.25% per year. The 0.75% figure is the cap on the distribution portion alone, and 1.00% is the total ceiling on 12b-1 charges for a fund that does not claim to be no-load. A fund with meaningful ongoing distribution fees is not truly no-load even without a front-end charge.FINRA Rule 2341 (Investment Company Securities)

A 45-year-old investor has $250,000 to invest for retirement in about 20 years and expects to add money over time. Which share class is generally most appropriate?

• a.Class B shares, because there is no front-end charge and the deferred charge falls to zero
• b.Class C shares, because there is no front-end charge and the annual fee of about 1% stays level
• c.Class A shares, because the large purchase qualifies for breakpoints and the ongoing expenses are lowest✓
• d.Class R shares, because the money is for retirement and they carry neither a front-end charge nor a deferred charge

A large, long-horizon investment favors Class A shares: the front-end charge is discounted by breakpoints and the low ongoing 12b-1 fee compounds into a smaller drag over two decades. Class B shares are rarely offered at this size and carry higher ongoing fees during the deferred-charge period. Class C shares charge a higher level fee every year, which over 20 years costs far more than a discounted front-end load. Class R shares are generally offered only through employer-sponsored retirement plans, not to an individual buying through a brokerage account, and they carry an ongoing distribution fee.

An investor plans to place $15,000 in a fund but expects to need the money in about two to three years. Which share class is generally most suitable?

• a.Class B shares, because the deferred charge is waived after one year
• b.Class A shares, because the front-end load is smallest over short periods of investment of only a year or two before the money is needed
• c.Class C shares, because there is little or no front-end charge and only a short contingent deferred charge✓
• d.No mutual fund is suitable for any holding period shorter than five years

Class C shares impose a level annual asset-based fee with at most a small CDSC that usually lapses after 12 months, which keeps costs low over a short holding period. A front-end load on Class A shares is paid up front and cannot be recovered in two or three years at this dollar amount. Class B deferred charges typically run several years, and it is not accurate to say no fund fits a short horizon.

Which statement most accurately describes Class B mutual fund shares?

• a.They pay no 12b-1 fee because the sales charge is deferred
• b.They may be redeemed at any time with no sales charge of any kind
• c.They carry a front-end sales charge and the lowest annual expenses of any class
• d.They carry a contingent deferred sales charge that declines each year and typically convert to Class A shares after a set period✓

Class B shares are sold without a front-end load but impose a back-end charge that steps down annually and eventually disappears, after which the shares usually convert to the lower-expense Class A shares. During the deferred-charge period Class B shares carry higher 12b-1 fees, not none. Redeeming early does trigger the CDSC.

A fund's expense ratio represents:

• a.The percentage of the portfolio turned over during the year through the manager's ongoing buying and selling
• b.The difference between the bid and the ask price of the shares as quoted for the shares in the secondary market
• c.Annual operating costs, including management and 12b-1 fees, as a percentage of average net assets✓
• d.The sales charge stated as a percentage of the public offering price charged at the time of each purchase

The expense ratio measures ongoing annual costs of running the fund, chiefly the advisory fee, 12b-1 fee, and other operating expenses, divided by average net assets. Sales charges are one-time transaction costs and are shown separately in the fee table. Portfolio turnover and the bid-ask spread are different measures entirely.

When a shareholder redeems open-end fund shares, the fund must transmit payment within:

• a.Seven calendar days✓
• b.Thirty calendar days
• c.One business day
• d.Three business days

The Investment Company Act of 1940 requires redemption proceeds to be paid within seven calendar days of a proper request, absent an SEC-permitted suspension. One and three days reflect general securities settlement conventions, not the statutory redemption deadline, and thirty days is far outside the requirement.Investment Company Act of 1940

To be classified as a diversified investment company, a fund must satisfy the 75-5-10 test, which requires that:

• a.At least 75% of assets be in equities, 5% in cash, and 10% in bonds
• b.At least 75% of assets be invested with no more than 5% in any one issuer and no more than 10% of any issuer's voting securities held✓
• c.No more than 75% of assets be in one industry, 5% in derivatives, and 10% in foreign issuers
• d.At least 75 different issuers be held, with 5% minimum and 10% maximum positions

The diversification test applies to 75% of total assets: within that portion, no single issuer may exceed 5% of assets and the fund may not own more than 10% of any issuer's voting stock. The remaining 25% is unrestricted. The other choices invent asset-allocation or issuer-count requirements that do not appear in the Act.Investment Company Act of 1940

Which statement correctly distinguishes accumulation units from annuity units in a variable annuity?

• a.Both the number of units and their value are fixed once the contract is issued
• b.Accumulation units have a fluctuating value but annuity units have a fixed value
• c.Accumulation units vary in number as the contract owner invests, while at annuitization a fixed number of annuity units is established whose value fluctuates✓
• d.Annuity units are purchased during the pay-in phase and accumulation units during the payout phase

During the accumulation phase, each purchase payment buys a varying number of accumulation units, so the unit count grows. At annuitization the accumulated value is converted into a fixed number of annuity units, and the payment changes only because the unit value moves with separate account performance. The other choices reverse the phases or freeze the wrong variable.

A variable annuity contract has an assumed interest rate (AIR) of 4%. In a month when the separate account earns 6%, the annuitant's next payment will:

• a.Be suspended until performance returns to the AIR
• b.Decrease compared with the prior payment
• c.Remain the same, because the AIR guarantees a level payment
• d.Increase compared with the prior payment✓

The AIR is the benchmark used to price annuity payments, so performance above it raises the annuity unit value and the payment goes up. Performance below the AIR would lower the payment, and performance exactly equal to it would hold the payment level. The AIR is a calculation assumption, not a guarantee, and payments are never suspended for poor performance.

Which annuity payout option generally produces the largest monthly payment for a given account value?

• a.Joint and last survivor
• b.Life with 20-year period certain
• c.Unit refund life annuity
• d.Straight life (life only)✓

A life-only payout ends at the annuitant's death with no residual benefit to anyone, so the insurer can pay the most each month. Every other option adds a guarantee to a second person or a minimum number of payments, and that added obligation reduces the monthly amount. Joint and last survivor typically produces the smallest payment because two lives must be covered.

A married couple, both age 66, want annuity income that continues for as long as either of them is alive. Which settlement option fits?

• a.Unit refund life annuity
• b.Straight life on the older spouse
• c.Joint and last survivor✓
• d.Life with 10-year period certain

A joint and last survivor option pays until the death of the second annuitant, which is exactly what the couple described. Straight life stops at the first death, leaving the survivor with nothing. A period certain or unit refund option guarantees only a limited number of payments or a return of principal, not lifetime income for the survivor.

A surrender charge on a deferred variable annuity is best described as:

• a.A contractual charge on early withdrawals that typically declines each year and eventually disappears✓
• b.A fee charged annually for as long as the contract is held
• c.A penalty imposed by the IRS on withdrawals before age 59 1/2
• d.A charge deducted from every purchase payment before it is invested in the contract's separate account subaccounts

The surrender charge is the insurance company's way of recovering distribution costs if the owner withdraws money during the early contract years, and the schedule steps down annually until it reaches zero. It is not an annual fee on all assets and it is not the IRS penalty, which is a separate 10% tax on premature distributions. Variable annuities generally have no front-end sales load deducted from deposits.

A customer wants to move the full value of an existing non-qualified variable annuity into a different insurer's non-qualified annuity. Handled correctly, this transaction:

• a.Triggers tax only on the amount that exceeds the original cost basis of the surrendered original contract
• b.Triggers ordinary income tax on the entire account value
• c.Is prohibited because annuity contracts cannot be transferred between insurers under the terms of state insurance law
• d.Is a 1035 exchange and is not a taxable event, though surrender charges may still apply✓

Section 1035 of the Internal Revenue Code allows an annuity-to-annuity exchange without current taxation as long as the funds move directly between carriers and the annuitant does not take possession. Cost basis carries over to the new contract. The exchange does not waive the old contract's surrender charges or the new contract's new surrender schedule, which is why suitability review is required.Internal Revenue Code Section 1035

Which of the following exchanges does NOT qualify for tax-free treatment under Section 1035?

• a.An annuity contract exchanged for a life insurance policy✓
• b.A life insurance policy exchanged for another life insurance policy
• c.A life insurance policy exchanged for an annuity contract
• d.An annuity contract exchanged for another annuity contract

Section 1035 permits life-to-life, life-to-annuity, and annuity-to-annuity exchanges, but not annuity-to-life, because that would move funds from a contract whose gains are always taxable into one whose death benefit can pass income tax free. The other three combinations are expressly allowed. Representatives must confirm the direction of the exchange before recommending it.Internal Revenue Code Section 1035

A 52-year-old owner of a non-qualified deferred annuity withdraws $20,000 from a contract with $60,000 of earnings and $40,000 of after-tax contributions. What is the tax result?

• a.The entire $20,000 is taxed as ordinary income and is subject to a 10% early withdrawal penalty✓
• b.The entire $20,000 is taxed as a long-term capital gain
• c.Half is ordinary income and half is a return of principal because the contract is treated as only partly annuitized
• d.The entire $20,000 is a tax-free return of principal

Non-qualified annuity withdrawals are taxed last-in, first-out, so earnings come out first and are taxed as ordinary income; because the owner is under 59 1/2, an additional 10% penalty applies to the taxable amount. Principal is not returned until all earnings have been withdrawn, so no part of this withdrawal is tax free. Annuity earnings never receive capital gains treatment.Internal Revenue Code

When a non-qualified annuity is annuitized, the exclusion ratio is used to:

• a.Calculate the surrender charge remaining on the contract during each remaining year of the payout phase
• b.Set the assumed interest rate for the payout phase
• c.Determine what portion of each payment is a tax-free return of the owner's after-tax cost basis✓
• d.Allocate the death benefit between beneficiaries

Once payments begin, each one is split between a tax-free recovery of the after-tax investment and a taxable portion representing earnings, and the exclusion ratio sets that split. Surrender charges, the AIR, and beneficiary allocations are governed by the contract, not by this tax formula. Once basis is fully recovered, later payments are fully taxable.Internal Revenue Code

In a scheduled premium variable life insurance policy:

• a.Both the death benefit and the cash value are guaranteed by the insurer for the entire life of the policy contract
• b.Neither the death benefit nor the cash value can change after issue
• c.A minimum death benefit is guaranteed, while the cash value is not guaranteed and may fall to zero✓
• d.The cash value is guaranteed but the death benefit varies with separate account performance in every policy year without exception

Variable life provides a guaranteed minimum face amount as long as scheduled premiums are paid, but the cash value rides entirely on separate account results and carries no floor. Guaranteeing the cash value would defeat the variable structure. The death benefit above the minimum can also rise with strong investment performance, so nothing about the policy is fully fixed.

A representative who wants to sell variable life insurance must hold:

• a.Only a state insurance license, because the product is an insurance contract
• b.Both a state insurance license and the appropriate securities registration✓
• c.Neither, if the policy is sold through an insurance agency
• d.Only a securities registration, because the separate account is registered with the SEC

Variable products are dual-regulated: the insurance element requires a state license, while the separate account interest is a security requiring FINRA registration through a broker-dealer. Holding just one credential is insufficient regardless of where the sale takes place. This is a central reason the Series 6 exists as a limited representative registration.Securities Act of 1933

Assets supporting a variable annuity's investment performance are held in:

• a.The broker-dealer's proprietary trading account
• b.A custodial bank account owned directly by the contract holder and held in the contract holder's own individual name
• c.The insurer's general account, where they are backed by the insurer's claims-paying ability and the insurer's own general reserves
• d.A separate account, which is registered as an investment company and holds the underlying subaccounts✓

Variable annuity assets sit in a separate account that is legally insulated from the insurer's creditors and registered under the Investment Company Act of 1940, usually as a unit investment trust. The general account backs fixed products, where the insurer bears the investment risk. Contract holders own an interest in the separate account, not the securities themselves, and no broker-dealer account is involved.Investment Company Act of 1940

Which feature distinguishes a unit investment trust from a management company?

• a.A UIT has a board of directors that hires an investment adviser
• b.A UIT actively trades its portfolio to outperform a benchmark
• c.A UIT holds a fixed portfolio, has no board of directors or investment adviser, and has a stated termination date✓
• d.A UIT issues shares that trade on an exchange at a premium or discount

A unit investment trust is organized under a trust indenture with a fixed, unmanaged portfolio and a preset termination date, so it needs neither a board nor an adviser. Active trading and adviser oversight are hallmarks of management companies. Exchange trading at a premium or discount describes closed-end funds, and UIT units are redeemable.Investment Company Act of 1940

Shares of a closed-end investment company differ from open-end fund shares because closed-end shares:

• a.Are always sold with a maximum 8.5% sales charge under FINRA's cap on total fund sales charges
• b.Are redeemable with the fund at net asset value on any business day at the shareholder's own request
• c.Trade in the secondary market at a price that may be above or below net asset value✓
• d.Cannot be purchased in the secondary market by retail investors through an ordinary retail broker-dealer

A closed-end fund issues a fixed number of shares in an offering and those shares then trade among investors, so supply and demand determine whether they sell at a premium or a discount to NAV. Redeemability at NAV is the defining feature of open-end funds. Closed-end trades involve brokerage commissions rather than the 8.5% sales charge ceiling, and any investor may buy them in the market.

An open-end investment company may issue:

• a.Only one class of voting common stock, with different sales charge arrangements permitted✓
• b.Common stock and long-term bonds, but no preferred stock
• c.Any capital structure approved by a majority of the board
• d.Both common shares and multiple classes of preferred shares that carry equal voting and liquidation rights

An open-end fund is limited to a single class of voting stock, though it may offer that stock through different sales charge structures such as Class A, B, and C shares. Senior securities such as preferred stock and bonds may be issued by closed-end funds, not open-end funds. The board cannot vote to override this statutory capital structure limit.Investment Company Act of 1940

A 529 college savings plan interest is classified for regulatory purposes as:

• a.An exempt security not subject to any securities regulation
• b.An open-end investment company registered under the Investment Company Act of 1940
• c.A variable annuity separate account interest
• d.A municipal fund security, subject to MSRB rules✓

Because 529 plans are established by states, their interests are municipal fund securities and sales practices are governed by MSRB rules rather than by the Investment Company Act. Investors receive an official statement or program disclosure document rather than a statutory prospectus. Calling them completely unregulated is wrong, as suitability, disclosure, and advertising rules all apply.Internal Revenue Code Section 529

A grandparent withdraws $8,000 from a 529 plan and uses all of it for the beneficiary's college tuition. The federal tax treatment of the earnings portion is:

• a.Taxable as ordinary income with a 10% penalty on the entire amount that was distributed
• b.Taxable as a long-term capital gain on the earnings that had accumulated in the plan
• c.Taxable to the beneficiary at the beneficiary's rate because 529 withdrawals shift the tax to the enrolled student
• d.Not taxable, because the distribution was used for qualified education expenses✓

Earnings in a 529 plan grow tax deferred and come out entirely free of federal income tax when the distribution pays qualified education expenses such as tuition. Tax and a 10% penalty on earnings apply only to non-qualified withdrawals. Contributions are made with after-tax dollars, so no federal deduction was taken going in.Internal Revenue Code Section 529

Which statement about control of a 529 plan account is accurate?

• a.Control passes to the beneficiary's parents once the beneficiary enrolls in college
• b.The state sponsoring the plan controls how the assets are invested
• c.The beneficiary gains full control of the account at the age of majority
• d.The account owner retains control, may change the beneficiary to another qualified family member, and may take a non-qualified withdrawal✓

Unlike a custodial account, a 529 plan leaves ownership and control with the person who opened it, including the right to redirect the funds to a different eligible family member. The beneficiary has no ownership right and never takes control by reaching a certain age. The state establishes the plan and its investment menu, but the owner chooses among the offered options.Internal Revenue Code Section 529

The Investment Company Act of 1940 classifies investment companies into which three types?

• a.Open-end funds, closed-end funds, and hedge funds as the categories defined by the statute
• b.Growth funds, income funds, and balanced funds, grouped by their stated investment objective
• c.Face-amount certificate companies, unit investment trusts, and management companies✓
• d.Mutual funds, exchange-traded funds, and separate accounts, the three statutory categories named in the Investment Company Act of 1940

The Act defines exactly three classifications, with management companies then subdivided into open-end and closed-end. Hedge funds are typically structured to rely on exclusions from the Act rather than being a statutory class. ETFs and separate accounts are organized within the existing classifications, and growth, income, and balanced describe investment objectives rather than legal form.Investment Company Act of 1940

To be treated as a regulated investment company and avoid paying tax at the fund level on distributed income, a fund must distribute at least:

• a.90% of its net investment income to shareholders✓
• b.75% of its realized capital gains
• c.50% of its net investment income
• d.100% of its gross income, since retained income is taxed twice

To be taxed as a regulated investment company, a fund must distribute at least 90 percent of its investment company taxable income, which exam materials call net investment income (Internal Revenue Code Section 852(a)(1)). Passing that test lets the fund act as a conduit and be taxed only on what it retains; failing it subjects all of its income to corporate tax, creating a second layer for shareholders. The 50 percent figure belongs to the asset diversification test, the fund-level tax is not limited to gains, and distributing all gross income is neither required nor possible after expenses.Internal Revenue Code Section 852(a)(1)

When must a prospectus be delivered to a purchaser of open-end fund shares?

• a.Only when the customer requests it in writing, because a registered fund's prospectus is otherwise available online
• b.Within 25 days after the sale, the aftermarket period dealers observe for newly listed offerings
• c.With or before the confirmation of the sale or the delivery of the shares✓
• d.Only for purchases of $10,000 or more, since smaller purchases are exempt from the delivery requirement

Section 5(b)(2) of the Securities Act makes it unlawful to carry or deliver a security for sale or after sale unless it is accompanied or preceded by a prospectus. Because open-end funds are in continuous primary distribution, every purchase is a new sale, so the buyer must receive the current prospectus with or before the confirmation or delivery of the shares. Delivery does not depend on a customer request or on a dollar amount. A delivery period after the sale, such as 25 days, would let the investor buy before seeing the disclosure.Securities Act of 1933 Section 5(b)(2) (15 U.S.C. 77e(b)(2))

A customer asks for more detail about a fund's officers, its brokerage allocation practices, and its full financial statements. This information is found in the:

• a.Form filed only with the state insurance commissioner and not made available to retail customers
• b.Statement of Additional Information, which must be provided free upon request✓
• c.Annual report only, which is sent every three years mailed only to the fund's shareholders of record
• d.Official statement filed with the MSRB

The Statement of Additional Information supplements the prospectus with detailed operational, governance, and financial disclosure and must be sent at no charge to any shareholder or prospective investor who asks. Shareholder reports are sent at least semiannually and contain less operational detail. Official statements relate to municipal securities and insurance filings to insurance products.Investment Company Act of 1940

For purposes of combining purchases to reach a breakpoint, which of the following does NOT qualify as a single "person"?

• a.An investment club whose members pool their money✓
• b.A husband and wife purchasing in a joint account
• c.A parent purchasing in a UTMA account for a minor child
• d.An individual investor

Breakpoint aggregation is available to an individual, a married couple, and their minor children's custodial accounts because those represent one family unit. Investment clubs, partnerships, and other groups formed mainly to obtain a reduced sales charge are expressly excluded. Allowing clubs to aggregate would let unrelated investors buy their way into discounts intended for a single household.FINRA Rule 2341 (Investment Company Securities)

A shareholder elects to have all fund dividends and capital gains distributions automatically reinvested. Those reinvested amounts purchase additional shares at:

• a.A breakpoint discount off the public offering price
• b.The public offering price, including the full sales charge
• c.Net asset value, no sales charge✓
• d.Net asset value plus a reduced load

Reinvested distributions buy shares at net asset value with no sales charge. FINRA Rule 2341(d)(6)(B) bars a member from selling shares of a fund that imposes a front-end or deferred sales charge on shares bought through reinvestment of dividends (for funds registered since April 2000). Charging a load on money that came out of the fund would penalize long-term holders. A breakpoint discount relates to the size of new purchases, not to reinvestments, and a reduced load is still a sales charge the rule does not allow.FINRA Rule 2341(d)(6)(B)

The principal purpose of the Securities Act of 1933 is to:

• a.Regulate trading on the exchanges and the over-the-counter market, and supervise the broker-dealers and exchanges that conduct it
• b.Set net capital and customer protection standards for the broker-dealers that sell new issues to the public
• c.Establish the SEC and require the broker-dealers that sell securities to the public to register with it
• d.Require full and fair disclosure of material facts when securities are offered to the public for the first time✓

The Securities Act of 1933 governs the primary market, requiring registration of new offerings and delivery of a prospectus so investors can judge the offering for themselves. Regulation of trading in the secondary market, creation of the SEC, broker-dealer registration, and net capital and customer protection standards all come from the Securities Exchange Act of 1934 and its rules.Securities Act of 1933

Registration of a securities offering with the SEC means that:

• a.The SEC guarantees the accuracy of the statements in the prospectus
• b.The issuer's financial condition has been certified as sound by the SEC
• c.The SEC has approved the offering as suitable for retail investors
• d.The issuer has filed the required disclosure and the SEC has not objected; the SEC does not approve the offering or vouch for its merits✓

The SEC's review is a disclosure review only; it never passes on the merits of an offering and it is unlawful to tell a customer otherwise. Suggesting approval, a guarantee of accuracy, or certification of financial strength misrepresents the agency's role. Every prospectus carries a disclaimer to this effect.Securities Act of 1933

Which of the following is an exempt security under the Securities Act of 1933?

• a.Common stock of a listed manufacturing company
• b.General obligation bonds issued by a state or municipality✓
• c.Units of a unit investment trust holding corporate bonds, which are exempt from registration as government-related instruments
• d.Shares of a newly organized open-end investment company

Municipal and U.S. government securities are exempt from the registration requirements of the 1933 Act, though the antifraud provisions still apply. Investment company shares, including UIT units, must be registered and sold with a prospectus. Corporate equity offerings are the classic example of securities that must be registered.Securities Act of 1933

During the cooling-off period for a registered offering, a representative may:

• a.Send a preliminary prospectus and accept non-binding indications of interest✓
• b.Confirm sales at the anticipated offering price once indications of interest have been collected
• c.Accept payment from customers who commit to buy
• d.Send research reports praising the issuer to prospective buyers to build early demand for the issue

Between filing and effectiveness, the only permitted activities are distributing the preliminary prospectus, or red herring, and gathering indications of interest that bind no one. Taking money, confirming sales, or circulating promotional material would be an illegal offer or sale of an unregistered security. Sales may occur only after the registration is declared effective and the final prospectus is available.Securities Act of 1933

The Securities Exchange Act of 1934 is best known for:

• a.Requiring a prospectus for every new issue of securities sold to the public in the primary market
• b.Establishing IRA contribution limits and the annual deferral caps for retirement accounts
• c.Defining the three classes of investment companies named in the Investment Company Act of 1940
• d.Creating the SEC and regulating the secondary market, broker-dealers, and exchanges✓

The 1934 Act created the SEC and gave it authority over trading markets, broker-dealer registration, reporting by public companies, and market manipulation. New-issue prospectus requirements belong to the 1933 Act, investment company classifications to the 1940 Act, and IRA rules to the Internal Revenue Code.Securities Exchange Act of 1934

Under the Investment Company Act of 1940, what portion of a registered fund's board must consist of directors who are not affiliated with the fund's adviser or underwriter?

• a.At least 40%✓
• b.No minimum is specified
• c.At least 10%
• d.At least 25%

The Act requires that non-interested, independent directors make up at least 40% of the board so that shareholder interests have meaningful representation when advisory contracts are reviewed. Many funds voluntarily exceed this level, but 40% is the statutory floor. The lower percentages and the claim that no minimum exists both understate the requirement.Investment Company Act of 1940

Before a newly formed open-end fund may offer shares to the public, the Investment Company Act of 1940 requires it to have:

• a.A net worth of at least $250,000 and a performance record of three or more years from its adviser's other funds
• b.More than 100 beneficial owners, the limit for a private fund under Section 3(c)(1)
• c.Written approval from the SEC, confirming that the shares are a sound investment
• d.A net worth of at least $100,000, or firm commitments to buy shares that bring it to that amount✓

Section 14(a) of the Investment Company Act prohibits a newly organized registered fund from making a public offering unless it has a net worth of at least $100,000, or unless firm commitments from a small number of purchasers will bring its net worth to that amount. There is no $250,000 minimum or required performance record, and a new fund has none by definition. The 100-owner figure belongs to the Section 3(c)(1) exclusion for private funds, not to the registered fund's seed requirement. The SEC declares a registration statement effective but does not approve the merits of the shares.Investment Company Act of 1940 Section 14(a) (15 U.S.C. 80a-14(a))

A fund's board wants to change the fund from a growth objective to an aggressive high-yield bond objective. This change requires:

• a.SEC approval, but no shareholder involvement
• b.Written notice to shareholders 30 days in advance, with no vote required
• c.Only a majority vote of the board of directors
• d.Approval by a majority vote of the fund's outstanding shares✓

A change in a fundamental investment objective or policy is reserved to shareholders and requires a majority vote of outstanding voting securities. Investors bought into a stated strategy, so the board alone cannot redirect their money. Notice without a vote and SEC approval without shareholder input both bypass the required shareholder franchise.Investment Company Act of 1940

Breakpoint selling is best defined as:

• a.Recommending Class A shares to a customer with a short time horizon
• b.Selling shares of two different fund families to the same customer
• c.Charging a sales load on reinvested dividends
• d.Recommending a purchase just below the amount that would qualify for a reduced sales charge, without disclosing the discount✓

Breakpoint selling deprives the customer of a quantity discount so the representative earns a larger commission, which is why it is treated as a sales practice violation. Diversifying across fund families is permissible when suitable, though it may forfeit breakpoints and should be discussed. Charging loads on reinvested dividends and mismatching share classes are separate problems.FINRA Rule 2341 (Investment Company Securities)

A representative repeatedly redeems a customer's shares in one fund family and reinvests the proceeds in a similar fund at another family, generating a new sales charge each time. This practice is called:

• a.Switching, and it is prohibited✓
• b.Selling dividends, a fully permissible way to boost a client's income before the record date
• c.Rights of accumulation, the recognized industry term for churning a fund position for extra commissions
• d.Front-running, the specific name the rules give to this repeated redemption-and-reinvestment pattern

Moving a customer between funds with substantially similar objectives solely to generate additional sales charges is switching, and absent a documented benefit to the customer it is a prohibited practice. Front-running involves trading ahead of a known block order. Selling dividends concerns timing a purchase around a distribution, and rights of accumulation is a legitimate breakpoint feature.FINRA Rules