CSLB General Building (B) — All Questions

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

• a.Regulate trading on exchanges and in the over-the-counter market
• b.Establish the SEC and require broker-dealer registration
• c.Require full and fair disclosure of material facts when securities are offered to the public for the first time✓
• d.Set minimum capital requirements for investment companies

The 1933 Act governs the primary market, requiring registration of new offerings and delivery of a prospectus so investors can judge the offering for themselves. Secondary market regulation, SEC creation, and broker-dealer registration come from the Securities Exchange Act of 1934. Fund capital requirements come from the Investment Company Act of 1940.Securities Act of 1933

Registration of a securities offering with the SEC means that:

• a.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✓
• b.The SEC has approved the offering as suitable for retail investors
• c.The SEC guarantees the accuracy of the statements in the prospectus
• d.The issuer's financial condition has been certified as sound by the SEC

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.Shares of a newly organized open-end investment company
• b.Common stock of a listed manufacturing company
• c.Units of a unit investment trust holding corporate bonds
• d.General obligation bonds issued by a state or municipality✓

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

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
• b.Creating the SEC and regulating the secondary market, broker-dealers, and exchanges✓
• c.Defining the three classes of investment companies
• d.Establishing IRA contribution limits

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

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.At least $100,000 of net assets and at least 100 shareholders✓
• b.At least $1 million of net assets and a five-year performance record
• c.A minimum of 500 shareholders and a state banking charter
• d.Approval from FINRA's board of governors

The Act sets a modest seed-capital requirement of $100,000 in net worth and a minimum of 100 shareholders before a public offering may begin, ensuring the fund is a genuine going concern. There is no performance-record or million-dollar requirement, and a new fund by definition has no track record. FINRA reviews underwriting arrangements but does not authorize the fund's existence.Investment Company Act of 1940

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

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

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

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.Front-running
• b.Selling dividends
• c.Switching, and it is prohibited✓
• d.Rights of accumulation

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

Urging a customer to buy fund shares immediately so the customer can "capture" an upcoming distribution is prohibited because:

• a.Distributions cannot be paid to shareholders of record for the first 30 days
• b.The share price drops by the amount of the distribution, so the customer gains nothing and incurs a current tax liability✓
• c.Funds are not permitted to pay distributions more than once a year
• d.The customer would be required to hold the shares for 12 months

Selling dividends is deceptive because the NAV falls by the distribution amount on the ex-date, leaving the investor with the same total value but an immediate taxable event. There is no 30-day record-date restriction, no annual limit on distributions, and no mandatory holding period. The customer is worse off after tax, which is why the pitch is prohibited.FINRA Rules

A representative learns that an institutional customer is about to place a very large buy order and immediately buys the same security for a personal account. This is:

• a.Permitted, because personal trades are unrelated to customer business
• b.Permitted if the representative discloses the trade to a supervisor afterward
• c.Permitted if the personal order is smaller than the customer's order
• d.Front-running, a prohibited practice and a form of market abuse✓

Trading ahead of a customer's known block order to profit from the expected price move misuses confidential customer information and is prohibited regardless of size or after-the-fact disclosure. The prohibition applies to accounts in which the representative has any beneficial interest. Supervisors cannot bless conduct that is itself a violation.Securities Exchange Act of 1934

A customer is nervous about market volatility and the representative offers to personally reimburse any losses in the first year. This offer is:

• a.Acceptable if the representative documents it in the client file
• b.Acceptable if the branch manager approves it in writing
• c.Acceptable only for accounts under $25,000
• d.Prohibited, because a registered person may not guarantee a customer against loss✓

Guaranteeing a customer against loss is flatly prohibited; it misrepresents the risk of the investment and creates an obligation the firm has not sanctioned. No amount of documentation, supervisory approval, or account size makes the promise permissible. Sharing in losses is permitted only under narrow joint-account rules with written firm and customer approval and proportionate capital contribution.FINRA Rules

A registered representative may share in the profits and losses of a customer's account only if:

• a.The customer requests it verbally and the representative keeps notes
• b.The firm and the customer give prior written approval and sharing is proportionate to the representative's financial contribution✓
• c.The representative contributes at least 50% of the account's capital
• d.The account is a joint account with an immediate family member of the customer

Profit sharing is permitted only with written consent from both the member firm and the customer, and the representative's share must match the money actually contributed. Verbal permission is never sufficient. There is no 50% contribution rule, and a family relationship between customer and representative does not by itself authorize sharing.FINRA Rules

A representative tells a prospect, "Buy this fund before Friday's record date so you get the $0.40 per share distribution for free." This statement is:

• a.Acceptable because the distribution is a real benefit to shareholders
• b.Acceptable if the customer is in a low tax bracket
• c.Prohibited, because it is selling dividends and misrepresents an economic benefit✓
• d.Prohibited only if the customer holds the shares less than 60 days

The pitch is selling dividends: the fund's NAV declines by the distribution amount, so the investor simply converts part of the investment into a taxable payment. A low tax bracket reduces the harm but does not make the misrepresentation acceptable. The violation lies in the misleading sales pitch, not in any holding period.FINRA Rules

Which of the following would most likely be viewed as a prohibited practice by a registered representative?

• a.Depositing a customer's check into the representative's own bank account overnight before forwarding it✓
• b.Recommending a Class A purchase at a breakpoint the customer qualifies for
• c.Sending a customer a copy of the fund's current prospectus
• d.Documenting a customer's risk tolerance before a recommendation

Commingling customer funds with a representative's personal funds, even briefly, is a serious violation and can constitute conversion. Recommending a breakpoint-qualified purchase, delivering a prospectus, and documenting risk tolerance are all required or encouraged practices. Customer checks must be forwarded promptly to the firm.FINRA Rules

Under FINRA's communications rules, a written message distributed to more than 25 retail investors within any 30 calendar-day period is classified as:

• a.Correspondence
• b.An institutional communication
• c.A retail communication✓
• d.A public appearance

The 25-recipient threshold in a rolling 30-day window separates correspondence from retail communications, and exceeding it triggers the stricter principal approval and filing framework. Institutional communications are those directed only to institutional investors. A public appearance covers unscripted live presentations rather than written material.FINRA Rule 2210 (Communications with the Public)

A representative emails an identical market update to 18 individual retail clients in one month. This communication is categorized as:

• a.A retail communication requiring pre-use principal approval
• b.An institutional communication exempt from review
• c.An advertisement requiring filing with FINRA
• d.Correspondence, subject to supervision and review procedures✓

Because the message reaches 25 or fewer retail investors within 30 days, it is correspondence, which firms must supervise and review under their written procedures but need not approve before use. Crossing the 25-recipient line would convert it into a retail communication. Retail clients are not institutional investors, and correspondence is not filed with FINRA.FINRA Rule 2210 (Communications with the Public)

An institutional communication is one distributed exclusively to:

• a.Any customer with an account balance over $250,000
• b.Institutional investors such as banks, insurance companies, registered investment companies, and qualifying entities✓
• c.Employees of the member firm
• d.Prospective retail customers who have signed a suitability waiver

The institutional category depends on the type of recipient, not on account size or paperwork, and covers entities such as banks, insurers, registered investment companies, and other qualifying institutions. A wealthy individual is still a retail investor. Suitability obligations cannot be waived by a customer signature.FINRA Rule 2210 (Communications with the Public)

Retail communications must generally be:

• a.Approved by an appropriately registered principal before first use or filing✓
• b.Approved by the SEC before use
• c.Reviewed by the fund's board of directors
• d.Approved by the customer in writing

A registered principal of the firm must sign off on retail communications before they are used or filed, which places accountability inside the member firm. The SEC does not pre-approve sales material, and fund boards oversee the fund rather than a distributor's advertising. Customers never approve communications directed at them.FINRA Rule 2210 (Communications with the Public)

How long must a member firm retain records of its communications with the public?

• a.Three years from the date of last use, and the first two years in an easily accessible place✓
• b.One year from the date of first use
• c.Five years from the date of creation
• d.Permanently, with no exception

Communications records must be kept for three years from last use, with the earliest two years readily accessible for examination. The one-year and permanent options misstate the requirement. The five-year period applies to certain anti-money laundering records, not to general communications.FINRA Rule 2210 (Communications with the Public)

A retail communication concerning a registered investment company that includes fund performance generally must be filed with FINRA:

• a.At least 10 business days before first use, in every case
• b.Within 10 business days of first use✓
• c.Within 90 days after the end of the calendar quarter
• d.Only if a customer complains about it

Most investment company retail communications are filed with FINRA's Advertising Regulation Department within 10 business days after first use. Pre-use filing applies to specific categories, such as material from a firm in its first year of membership or communications about certain complex products. Quarterly batching and complaint-triggered filing are not part of the rule.FINRA Rule 2210 (Communications with the Public)

Which practice is permitted when presenting mutual fund performance in a retail communication?

• a.Showing only the fund's best three-year period
• b.Projecting the fund's expected return over the next five years
• c.Describing a bond fund's yield as guaranteed because the portfolio is investment grade
• d.Showing standardized average annual total returns for 1-, 5-, and 10-year periods, or the life of the fund✓

Standardized total returns for the required periods, current as of the most recent quarter end, give investors a consistent basis for comparison. Cherry-picking a favorable period, projecting future performance, and calling any return guaranteed are all misleading and prohibited. Communications must also disclose that past performance does not predict future results.FINRA Rule 2210 (Communications with the Public)

A firm wants to include a customer testimonial in a retail communication. Which requirement applies?

• a.Testimonials are prohibited in all securities communications
• b.The testimonial must be notarized by the customer
• c.The communication must disclose that the experience may not be typical and, if compensation was paid, that fact must be disclosed✓
• d.The testimonial must be filed with the SEC before use

Testimonials are allowed with clear disclosure that the quoted experience is not necessarily representative and that any material payment to the person was made. Notarization is not required, and pre-use SEC filing is not part of FINRA's advertising framework. Testimonials about technical securities advice also require disclosure of the speaker's qualifications.FINRA Rule 2210 (Communications with the Public)

A customer deposits $12,000 in cash in a single business day. The firm must file:

• a.A Suspicious Activity Report only
• b.A Currency Transaction Report✓
• c.Form 1099-B with the IRS
• d.Nothing, because the deposit is under $25,000

Currency transactions of more than $10,000 in one business day trigger a Currency Transaction Report under the Bank Secrecy Act, regardless of whether anything appears suspicious. A SAR is required only when the activity itself raises suspicion. Form 1099-B reports proceeds of sales, not deposits.Bank Secrecy Act

When a firm files a Suspicious Activity Report on a customer's transactions, the firm:

• a.Must not notify the customer that a SAR was filed✓
• b.Must give the customer a copy within 10 business days
• c.May notify the customer only with the customer's written consent
• d.Must close the account immediately

Tipping off a customer about a SAR filing is prohibited because it would compromise any resulting investigation. SARs generally apply to suspicious transactions of $5,000 or more and are filed with FinCEN, typically within 30 days of detection. Filing does not automatically require closing the account, though the firm may choose to do so.Bank Secrecy Act

A firm's customer identification program must, at a minimum, collect which information from a new individual customer?

• a.Employer name, annual income, net worth, and investment experience
• b.Credit score, marital status, and number of dependents
• c.Name, date of birth, physical address, and taxpayer identification number✓
• d.Passport number and two professional references

The customer identification program requires name, date of birth, a street address, and a government identification number so the firm can form a reasonable belief that it knows the customer's identity. Financial profile items such as income and net worth are gathered for suitability purposes, not identity verification. Credit scores and references are not CIP elements.USA PATRIOT Act

Before opening an account, a firm must check the prospective customer's name against the list of Specially Designated Nationals maintained by:

• a.FINRA's Central Registration Depository
• b.The Municipal Securities Rulemaking Board
• c.The Securities Investor Protection Corporation
• d.The Office of Foreign Assets Control✓

OFAC publishes the Specially Designated Nationals list, and firms are prohibited from doing business with parties named on it. The CRD holds registration records for individuals and firms, the MSRB writes municipal rules, and SIPC provides limited account protection if a broker-dealer fails. None of those three maintains sanctions lists.USA PATRIOT Act