Series 63 Binder

NASD Series 63 Uniform Securities Agent State Law Examination Review

®

SuccessTrak Series Professional Training Services, Inc. 579 N 1st Bank Drive – Suite 210 Palatine, Illinois 60067 (847) 705-3838 * (800) 526-6497 * Fax (847) 705-3837 www.ptstraining.com

Professional Training Services, Inc. 2003 © All rights reserved by Professional Training Services Inc. No part of this publication may be reproduced, stored in retrieval system, or transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of Professional Training Services, Inc., the copyright holder. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author or company is engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. By using this workbook you are agreeing that you have been granted a personal, limited, nontransferable license for your personal use only. Recirculating or sharing these materials are strictly prohibited. SuccessTrak® is a registered trademark belonging to Professional Training Services, Inc. Printed in the United States of America. ____________________________________________________

Professional Training Services, Inc. 579 N. 1st. Bank Drive Suite 210 Palatine, Illinois 60067 (847) 705-3838 www.ptstraining.com October 2001- March 2003 032403

Table of Contents Chapter 1: Definitions ...................................................................... 13 Person Defined ...................................................................................13 Broker-Dealers ..................................................................................13 Definition of a Broker-Dealer ............................................................ 13 Broker-Dealers EXEMPTED from registration ..................................14 Broker/Dealer Capacity .......................................................................14 Registration of Broker-Dealers ...........................................................15 Agents .................................................................................................15 Definition of an Agent ........................................................................15 Agents Exempted ................................................................................18 Chapter 2: Investment Advisor and Other Definitions .................19 Investment Advisers ......................................................................... 19 Definition of an Investment Adviser .................................................. 19 Investment Advisor Registration .........................................................19 Exclusions to the IA Definition .......................................................... 19 Exemptions to the IA Definition ........................................................ 20 Federal vs. State Registered Investment Advisers ............................. 20 Registration Information for Broker-Dealers and Advisers ........ 20 Registration Rule ................................................................................ 21 Registration Application Information ................................................ 21 Other Registration Requirements ....................................................... 22 Registration Standards for Broker-Dealers and Investment Advisers 22 Other Investment Adviser Stuff ...................................................... 23 Investment Advisory Contracts .......................................................... 23 Custody of Customer Funds and/or Securities ................................... 23 Customer Disclosures ......................................................................... 24 Consent to Service of Process ............................................................ 24 Investment Adviser Representative ................................................ 24 Definition of an Investment Adviser Representative ..........................24 Registration Requirements for Investment Adviser Representatives . 25 Registration Standards for Agents and Investment Adviser Reps ..... 25 Ongoing Requirements .................................................................... 25 Books and Financial Records ............................................................. 25 Customer Reports ............................................................................... 25 Financial Reports ............................................................................... 26 No Inaccurate Information ................................................................. 26 Inspections .......................................................................................... 26

Chapter 3: Definition and Examples ...................................29 Definition of a Security .........................................................29 Definitions of a Sale, Offer to Sell & Offer to Purchase.......29 Exclusions from the Definition ............................................29 Other Definitions ...................................................................30 Types of Securities ................................................................30 Corporate Securities ................................................................30 Government Issues ..................................................................30 Options Clearing Corporation Issues ......................................31 Investment Company Issues ...................................................31 Tax Sheltered Issues ...............................................................31 Other Issues Considered to be Securities ................................31 Issuer and Issuer Related Definitions .................................32 Definition of a Non-Issuer ....................................................32 Federally Covered Securities ...............................................32 Some examples of these include; ............................................33 Chapter 4: Registration of Securities ..................................35 Registration of Securities .....................................................35 Types of Securities Registration ..........................................35 Registration by Filing (Also known as Notification) ..............35 Registration by Coordination ..................................................36 Registration by Qualification ..................................................37 General Rules Regarding Securities Registrations .................38 Denial, Suspension and Revocation of Registration ..........38 Chapter 5: Exempt Securities and Transactions ...............41 Exempt Securities .................................................................41 Exempt Transactions ............................................................41 Revocation of an Exemption ................................................42 Chapter 6: Federal Covered Securities ...............................45 Overview ................................................................................45 Chapter 7: Sales and Purchases ..........................................49 Background ...........................................................................49 Failure to State Important Facts .........................................50 Use of Non-Public Information ............................................50 Suitability Issues ...................................................................51 Disclosure of Material Information .....................................51 Other Prohibited Acts ..........................................................51 Communicating with Clients ...............................................53 Advertising and Sales Literature .............................................53 Deny, Revoke or Suspend Registration ...............................53

NASD Series 63

Cancellations and Withdrawals ...........................................53 Chapter 8: Powers of Administrator, Liabilities and Penalties ...........................................................................................57 Powers of the Administrator ................................................57 Criminal Liabilities and Penalties .......................................57 Civil Liabilities under the Act ..............................................57 If the Investor Still Owns the Security ....................................58 If the Investor No Longer Owns the Security .........................58 Transactions Where Civil Liability Applies ...........................58 Offer of Rescission ................................................................59 Scope of the Act and Jurisdiction ........................................59 Scope of the Act ......................................................................59 Jurisdiction of the Administrator ............................................59 Jurisdiction over Offers Made in the Media ...........................60 Situations to think about .........................................................60 Important Terms ...................................................................63 CBT Instructions ...................................................................67

NASD Series 63

Introduction to SuccessTrak® Series 63 Welcome to SuccessTrak®. The goal of all our programs is to make your study experience effective, efficient, enjoyable and most of all, successful. The Series 63 exam is made up of (4) major sections, known as the Uniform Securities Agent State Law Examination (USA). In addition, as part of the SuccessTrak® Series 63 program, a Series 63 Computer Disk is included with this workbook. Our materials are concise and get right to the point without adding any unnecessary material. Our primary goal is for you to pass the Series 63 exam in a timely and efficient manner.

Major Sections of the Series 63 Exam Section

Subject

Percent of Exam

Number Questions

1

Registration of Persons

30%

18

2

Securities

25%

15

3

Business Practices

35%

21

4

Administrative Provisions and Other Remedies

10%

6

Our Commitment Our goal and primary mission is to provide you with the best quality, concise and accurate information in the industry. By following our recommended strategy you will pass the NASD Series 63 exam! Series 63 Exam The NASD requires a minimum passing score of 70% in order to be eligible for NASD registration as an Agent. This exam is required if registered representatives solicit business in other states than the one registered in. Some states require this qualification in order to be NASD securities licensed. The exam’s purpose is to test your knowledge of the Uniform Securities Act, referred to as USA as well as the Act. This score is based on the overall exam, not each individual

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subject section. There are a total of 65 multiple choice questions with 60 questions that count with a time limit of 75 minutes. The Series 63 Exam is administered at Prometric computerized testing centers. When your broker-dealer registers you to take the exam you will receive an admission ticket which is good for a period of 120 days. Your broker-dealer will also advise you of the location of the nearest Proctor® testing center. Prometric Examination Center Upon arrival at the test center you will sign in and a thumb print will be taken. Be prepared to show a picture ID as well as another form of ID. Only calculators capable of basic math functions such as addition, subtraction, multiplication and division are permitted. You will be provided with pencils and four or five sheets of scratch paper which must be returned upon completion of the exam. After completing all the questions, assuming you do not run out of time, you will be asked if you have completed the exam. Upon affirmation of this the exam is graded automatically in seconds. Shortly thereafter, your score along with a breakdown of each of the four sections will appear on your screen. Upon completion of the exam you will be asked to complete an examination center survey. You will also receive a hard copy of your test results which will be available for you upon leaving. A copy of your test results will be sent to the NASD and they will forward the results to your sponsoring broker-dealer. Study Time It is recommended that you spend approximately 16 - 20 hours reading the materials and working out the practice questions on the computer CD. This is an average so some students may require less while others may require more. Recommended Study Method The best way to approach your studies with the Series 63 is to review each of the Sections independently, chapter by chapter. Upon completion of each chapter complete the chapter review questions with at least a score of 80% or better before moving on to the next chapter. Upon completing each section you should review the “Section Questions” on the computer CD Rom attached to the inside of the back cover. The questions in each of the computer CD Rom’s sections relate to each of the four sections of this workbook. (CD Rom exam review installation instructions can be found in Appendix B) There’s an extensive Glossary located in Appendix A of this workbook. Whenever you are “stumped” or need to verify a definition you should immediately turn to the glossary for help. The workbook should be used in conjunction with the CD Rom.

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Upon completion of all four sections in this workbook and completion of the four sections of review questions on the computer CD Rom, you should then complete the two 65 final question exams also located on the computer CD Rom. The goal is to attain scores of at least 80% or preferably 90% to be ready to take the NASD Series 63 Exam. Plan on spending 75 minutes on each of the two final exams, just like the actual exam. Rationale and explanations are available for all section review questions as well as for final exams. Test Taking Techniques Reading comprehension is an important part of being successful with all NASD exams. It is imperative that you develop and/or improve appropriate test taking techniques including the following: Understanding what they are asking It is important that you read each question at least three times prior to choosing your answer. It is important that you do not jump to conclusions. It is not unusual that a question starts with what appears to be a specific set of facts but changes midstream to other facts. If you jump to a conclusion without adequate review you may choose the “false answer” fitting those beginning facts. Look out for clauses or qualifiers such as if, all, not, none and except. They are often used in NASD questions. Obviously, the use of these clauses would require a different answer than if the question was asked without them. Let’s take a look at an example: Question 1 “Persons”, as defined under the USA, include which of the following, EXCEPT? I. Individuals II. Corporations III. Minors IV. Estates A. I and II B. III only C. II, III and IV D. III and IV Under the Uniform Securities Act (USA) all are defined as a “person”, except a minor.

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Don’t panic even though you may see questions that initially look unfamiliar. In a number of questions you are going to have to interpret a set of facts and come to a conclusion in the form of a test answer. At the same time you may be asked, in these type of questions, combination subjects such as the following example; Question 2 When the economy experiences an upward trend due to inflation what is the general effect on interest rates? A. Rates go up B. Rates go down C. Rates stay the same D. Rates won’t vary with inflation This question is asking you the result of an increase in inflation, not what inflation is. The correct response is A, interest rates go up with inflation. This of course will cause the Federal Reserve Board to take action sooner or later and they will increase rates even further which ultimately will cause the values of debt instruments to decrease. See what we mean? Just look at all the results that can be the subject of test questions regarding the subject of inflation. Eliminate Roman Numeral Type Question Choices These types of questions are quite popular on NASD exams. However, if analyzed properly they can work in your favor. Always attempt to eliminate one or more of the available choices. If successful you may be able to narrow down your options to the correct answer or minimally down to 50% of the choices. (There are anywhere between 30% - 45% of these type questions on the exam) Question 3 Administrators can require minimum Net Capital and Net Worth for which of the following? I. Issuers II. Investment Advisors III. Broker-Dealers IV. Agents A. I and IV B. II, III and IV C. II and III D. I, II, III and IV If you were able to eliminate choice IV. agents, C would be the only possible choice as IV is present in choices A, B and D.

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Make sure you understand the intent of the question Very often in NASD exams, including the Series 63, questions have so much information that you lose track of what is being asked. Not only that, the irrelevant facts in the question may cause you to make an incorrect choice because of not following and understanding what is being asked. Look for clues in the body of the question and be prepared to disregard irrelevant facts and issues. Use Time Management You will find that 75 minutes is plenty of time to complete the Series 63 exam. However, at the same time, when taking practice questions watch your timing. If you encounter a question containing an issue which you do not immediately recognize, looks difficult, or requires a lot of mathematical computations mark it for review and complete it after completing all the other questions. This will help prevent losing track of time and then panicking and rushing through the end of the exam questions. Final Thoughts on Test Taking Techniques • Pace yourself • Read all of the materials in this workbook • Read the questions over and over until you understand what they are asking of you prior to making a choice • Don’t read the questions too fast. It is important you don’t formulate an answer too quickly. • Avoid changing answers. If you do, you are really second guessing yourself and will probably be wrong 85% of the time. • Making careless errors is generally caused by having preconceived notions when reading a test question. Read what is written, not what you expect to see. Don’t add your own thoughts to a question. • Practice all furnished test questions with the goal of scoring between 80 – 90% prior to taking the exam • Understand concepts – don’t memorize questions, but memorize all definitions • Don’t whine about questions or the exam • Practice, practice, practice test questions • Pay close attention to those sections market “Test Clue”. There is an excellent chance you will be tested on that exact point.

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NASD Series 63

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Section 1: Registration of Persons 18 Questions – 30% This section contains information about the registration of persons which includes broker-dealers, agents, investment advisers and more. Also included are ongoing requirements such as books, records and financial reporting.

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Definitions

Chapter 1: Definitions 1.1 PERSON DEFINED Throughout the USA the term “person” is referred to. It is important to understand what “person” refers to and all of its uses. Persons can be defined as follows; • Individuals (just like you) • Corporations • Partnerships • Business trusts • Estates • Joint venture or joint stock company • Governments • Political subdivisions of Governments • Associations 1.2 BROKER-DEALERS 1.2.1 Definition of a Broker-Dealer It is most important that you know and understand the definition of a broker-dealer as all broker-dealers must register in every state it conducts business in unless an exemption exists. So, let’s take a look at the definition of a broker/dealer; • A broker-dealer is a “person” who engages in the business of effecting securities transactions for the account of others or for their own account (known as proprietary trading) 1.2.1.1 Exclusions from the Definition of Broker-Dealer The term broker-dealer does not apply to the following definitions and therefore they do not have to register as a broker-dealer under the USA; • Agent: Individuals who represent a broker-dealer when performing securities transactions. An agent is basically a sales representative or registered representative of the broker-dealer. Remember - an Agent cannot be a broker-dealer

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Definitions • Banks, savings and loans and trust companies (They are separately regulated under Federal and State banking laws) • Issuers and “agents” of issuers • Persons” who have no place of business in the state and; - Only transact business with other broker-dealers, institutional buyers, issuers or financial institutions - Is licensed in the state where the person maintains a place of business and only makes offers to existing customers who are not a resident of that state. (This allows doing business with a client who is on vacation in another state) - The firm has no place of business in a State where an existing customer is vacationing and contacts the customer in that State. Test Clue: Make sure you understand which broker-dealers are EXCLUDED from registration and those that are EXEMPT from registration. There is a difference between those two words. Anything that is excluded may required the person or persons claiming the exclusion to prove as to why the exclusion should apply. However, anything that is exempt is done so by operation of law and no proof is required on behalf of those claiming the exemption. Exam Example: Suppose the Peace of Mind brokerage firm located in downtown Aurora, Illinois makes regular calls to mutual fund money managers in Minneapolis, Minnesota offering to sell securities to them. However, Peace of Mind does NOT have an office in Minneapolis. It needs to be pointed out that the Peace of Mind brokerage firm does NOT deal with any retail investors in Minneapolis. Under the USA, Peace of Mind is not considered a broker-dealer in Minneapolis, Minnesota, because of the following reasons; • It has no place of business in Minnesota, AND • It deals only with institutional investors in Minnesota 1.2.2 Broker-Dealers EXEMPTED from registration Broker-dealers that have no place of business in a State with 5 or fewer clients in that State in a 12 month period of time.

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Definitions

1.2.3 Broker/Dealer Capacity Broker/Dealer Acting in an Agency Capacity When a brokerage firm effects trades for the accounts of others they are acting in an agency capacity and charge a commission. Broker/Dealer Acting in a Principal Capacity When a brokerage firm effects trades for its own account and brings the security into its own inventory it is at risk and acts as a principal/dealer, not an agent. When it sells the security to a customer it will mark up the price of the security instead of charging a commission. A broker-dealer acting as a principal assumes more risk than if acting as an agent. 1.2.4 Registration of Broker-Dealers • The USA states that it is unlawful for any person to transact business in the State as a broker-dealer or agent unless that person is registered in the State. • Broker-dealers are prohibited from employing an agent unless the agent is registered. If an agent (must be an individual) is no longer employed by that firm, the registration ceases. • If a broker-dealer loses its registration voluntarily or otherwise, its agents are no longer registered with that firm. Until they become associated with another brokerage firm the agents cannot act as an agent and transact business with customers. • If an agent moves from one broker-dealer to another, the agent, the prior employer and the new employer must promptly notify the Administrator of the change. • Agents must register with the State Administrator through a broker-dealer, not directly. • Most states prohibit agents from registering with multiple broker-dealers. In most instances an agent will only be allowed to register with one brokerdealer at a time. (No dual registration) 1.3 AGENTS 1.3.1 Definition of an Agent Know this definition as it is quite important. If a person is defined as an agent, state registration is required under the Act. • An agent, known as a sales representative and a registered representative, is any individual who represents a broker-dealer or an issuer in effecting securities transactions.

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Definitions • There is no requirement that an agent earns a commission under the USA. Agents may be compensated with a salary or with commissions. • Employees of brokerage firms who only perform clerical or managerial functions and do not effect trades are excluded from the definition of an agent and thus are not required to be registered. As an example, a partner of the brokerage firm who has no sales function and who does not effect trades is not required to register in the state as an agent. 1.3.1.1 Exclusions from the Definition of Agent Test Clue: Basically, exclusions only apply to individuals who represent issuers of exempt securities and exempt transactions but do NOT apply to individuals who represent broker-dealers. Individuals who represent issuers in trading the following exempt securities would be excluded from the definition of agent: • Foreign Government • Municipal Government • Canadian Government • Bank and Savings Institutions • Trust Companies • U.S. Government • Commercial paper with a maximum maturity of 270 days or less • Securities in conjunction with savings, pension, profit sharing plans and employee stock option plans. • Individuals who represent issuers in exempt transactions are also exempt from the definition of agent. Generally speaking, exempt transactions do not usually involve the public. - Transactions between the issuer and the underwriter - Transactions with financial or institutional investors such as banks, trust companies, savings institutions and pension plans. - Transactions effecting employees, officers, partners and directors of the issuer when no compensation is paid to the individual for their solicitation - Private placements (not a public offering of securities) - Sales to qualified purchasers

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Definitions

1.3.2 Agents Exempted • Agents who act for excluded or exempt broker-dealers are also exempt from registration. • In two situations agents of broker-dealers may engage in securities transactions in a state BEFORE their registration is effective. This is known as the de minimis rule for agents. They are; - If an agent’s application for registration is pending in a state, the agent may engage in transactions for up to 60 days with an existing customer who has moved into the state (unless the state earlier denies the agent’s application). - The agent may engage in transactions with an existing customer who is in the state temporarily (less than 30 days). This assumes the following conditions are met before the above rule applies; • The agent must not be ineligible to register in the state • The agent’s broker-dealer must be registered in the state • The agent must be registered with a national securities association such as the NASD • The agent must be registered in at least one other state 1.3.2.1 Example of the De Minimis Rule Exemption Trish K is a registered representative (agent) of the Peace of Mind brokerage firm. One of Trish’s best clients, by the name of Paco, has been with Trish for nearly 10 years. But Paco is moving from Illinois, where Trish and Peace of Mind are located, to Florida. Paco would like Trish to continue handling his account, even though Peace of Mind has another office in Florida. If Paco moves and Trish applies to register as an agent in Florida, does she have to wait until her registration is effective before continuing to service Paco’s account? No, because of the de minimis rule for agents, Trish may engage in transactions for Paco, even though he now lives in Florida, for up to 60 days assuming the four conditions stated in 1.3.2 are met. However, if the Adminstrator of Florida denies Trish’s application within that 60-day period, she must immediately stop acting as an agent in that state.

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Definitions 1.3.3 Agents for Issuers Not Exempted • Individuals who represent issuers in effecting securities transactions are usually agents as well as long as the security or transaction is NOT exempt. Example 1: Issuer Agent Peggy Sue represents the Futuristic Company as president of the company. In an effort to help raise capital through a stock offering, Peggy Sue sells Futuristic shares of stock to several of her golfing buddies. By doing this, Peggy Sue is representing Futuristic in effecting securiteis transactions and would be considered to be an agent of Futuristic and therefore subject to all applicable rules and regulations and must therefore register with the state Administrator. Example 2: Not an Agent Assume Futurstic Company allows its employees to buy company stock and an employee by the name of John, a Human Resources manager, arranges those transactions. On the surface it appears that he should be considered to be effecting securities transactions for Futuristic and should have to register. BUT, if John does not solicit transactions and arranges them only when initiated by an employee, he is NOT an agent because of the exceptions listed on the prior page in Section 1.3.1.1.

End of Chapter One

NASD Series 63

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Investment Advisor and Other Definitions

Chapter 2: Investment Advisor and Other Definitions 2.1 INVESTMENT ADVISERS 2.1.1 Definition of an Investment Adviser Under the USA, an investment advisor is defined as any person who receives compensation, whether directly or indirectly, for advising others as to the value of securities, or their purchase or sale, whether through the issuance of analysis, reports or otherwise. 2.1.2 Investment Advisor Registration Investment advisers must register in states when as a person, for compensation; • Provides advice, analysis or reports concerning securities • Provides investment advisory services to others in a financial planning practice • Provides these services in the regular course of their business • Must NOT employ any device, scheme or artifice to defraud • Engage in any dishonest or unethical practices as defined by the administrator. 2.1.3 Exclusions to the IA Definition Exclusions from the definition of Investment Advisor (If excluded none of the following would have to register as an investment adviser) • Banks, savings institutions or trust companies • Professionals whose investment advice is an incidental portion of their business practice - Lawyers - Accountants - Teachers - Engineers Test Clue: You will get a question right on this point. Most of the time th e exam will substitute one of the above with another occupation such as an “economist” instead of an “engineer”.

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Investment Advisor and Other Definitions

• Broker-dealers whose advice is incidental to their normal business practice and who receive no special compensation for this advice. • Publishers of bona-fide newspapers with a national circulation, news magazines, business or financial periodicals and owners and employees of cable, radio or television networks who do not render advice about specific investment situations or individual clients. • Federal Covered Advisors who are registered directly with the SEC • Any other person so designated by the State Administrator. • Advisors having NO place of business in the state, and - Their only clients are other investment advisers, broker-dealers, banks, trust companies, financial institutions, insurance companies, investment companies, employee benefit plans and government agencies. • Giving advice solely to employee benefit plans with at least $1,000,000 in assets. • Those who register as Investor Adviser Representatives. • Individuals who solely perform clerical or ministerial duties. 2.1.4 Exemptions to the IA Definition Exemptions from the definition of Investor Adviser Registration and therefore exempted from being licensed as an investment adviser.: The Act exempts the following investment advisers from licensing and registration requirements as long as Advisers have no place of business in the State and whose only clients in the State consist solely of the following: • Doing business only with other investment advisers • Broker-dealers • Federal covered advisers • Banks, savings and loans, trust companies • Insurance companies • Investment companies under the Investment Company Act of 1940 • Government agencies • Employee benefit plans • Under the De Minimus rule, advisers who have no place of business in the state and communicate with no more than 5 clients in a 12 month time period.

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Investment Advisor and Other Definitions

• Anyone designated by the Administrator 2.1.5 Federal vs. State Registered Investment Advisers Under the National Securities Act of 1996 different registration requirements were established for investment advisers. Those advisors who must register with the SEC as a Federal Advisor would not be required to register under this Act with the states. A federally registered advisor is defined as; • Advisors with assets over $25,000,000 under management must register with the SEC, a federal agency. • Advisers with assets under $25,000,000 must register at the state level. • Federal covered advisers must still file notice in the state or states they’re working in and pay any required fees. • Investment advisers advising registered investment companies 2.2 REGISTRATION INFORMATION FOR BROKER-DEALERS AND ADVISERS 2.2.1 Registration Rule It is unlawful under the USA for any person to conduct business as an investment advisor if not excluded or exempted until they register with the SEC if federal registration is required or register with the states if state registration is required. 2.2.2 Registration Application Information State Administrators require the following information on registration applications; • Form of business such as a corporation, partnership or sole proprietorship. • Location of the business • Proposed method of doing business • Business history • Qualifications of the applicant, partners and/or officers • Fingerprints of partners, directors or officers of broker-dealers, investment advisers and investment adviser representatives • Applicant’s financial history and current condition • For investment advisers only, any information required to be furnished to any client or prospective client • Listing of any injunctions or administrative orders against applicant

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Investment Advisor and Other Definitions

• Disclosure of any convictions relating to misdemeanors in the securities business and any type of felony 2.2.3 Other Registration Requirements • The State Administrator can require an applicant for initial registration to publish an announcement of the application in one or more newspapers published in the State. • Federal covered advisers must file notice in the State by filing with the State the same documents as have been filed with the SEC • Initial filing fees must be filed for the registration of; - Investment advisers - Broker-dealers - Agents - Investment Adviser Representatives • Annual renewal fees must be paid on time Test Clue: Registration is effective 30 days from the filing date. If there are any required amendments then registration would be effective 30 days from the amendment filing date. • Renewal periods vary from state to state. However, for exam purposes renewals are from calendar year to calendar year. So, registrations must be renewed by December 31st of each year • For agents or investment adviser representatives that are registered with the SEC through the NASD (Central Registration Depository – CRD) state information requirements would be satisfied. 2.2.4 Registration Standards for Broker-Dealers and Investment Advisers For the most part registration standards are almost the same for both broker-dealers and investment advisers. Unless noted otherwise, the following standards apply to both; • The State Administrator can require the maintaining of a Minimum Dollar Amount of Net Capital. The purpose of this is to protect investors from possible business failure of a broker-dealer and/or investment adviser. • Surety Bond Coverage (amounts set by State Administrators) are used to ensure performance by broker/dealers and investment advisers under current securities laws. Broker-dealers and investment advisers who have net capital

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Investment Advisor and Other Definitions

in excess of the minimum requirement may not be required to have a surety bond. Also, if investment advisers do NOT take custody of customer funds and/or securities there may NOT be a surety bond requirement. • State Administrators can require higher bond requirements for those investment advisers who do take custody of client’s funds and/or securities and those investment advisers who have discretionary authority over a client’s account. Test Clue: The former Surety Bond law required a minimum of $10,000 coverage. However, today the State Administrators can require any amount they deem reasonable. And once again, in lieu of a surety bond a cash deposit used as net capital could be required. • The passing of a qualification examination. However, just passing the exam is NOT by itself authority to transact business. Applicants may not transact business until all required items are filed and the registration is granted by the administrator. • Financial reports as required by the State Administrator need to be filed. 2.3 OTHER INVESTMENT ADVISER STUFF 2.3.1 Investment Advisory Contracts Investment advisors are prohibited from entering into, renewing or extending an advisory contract unless the contract is in writing. The provisions of the contract must state that the investment adviser: • Cannot assign the contract without the consent of the customer • Cannot be compensated on the basis of capital gains or capital appreciation of funds in the account unless the fee is based on the total value of all assets being managed • If the investment adviser is a partnership, the customer shall be notified within a reasonable time of any changes in the members of the partnership. 2.3.2 Custody of Customer Funds and/or Securities If an advisor takes custody of customer funds or securities the advisor must; • Keep them segregated and held in safekeeping. • A written notice must be given to the customer of the location of the securities and/or funds in custody. • Provide customers at least quarterly a statement of account from the adviser.

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Investment Advisor and Other Definitions

• Notify the administrator if they have or will take custody of a customer’s funds or securities. The administrator has the authority to sanction or disallow an advisor from maintaining such custody. Test Clue: It is prohibited for an investment advisor to have or take custody of customer funds and/or securities if; • The Administrator prohibits this by rule; or • If there is no rule, the adviser fails to notify the Administrator that he has, or will be taking custody of client funds and/or securities 2.3.3 Customer Disclosures If an investment adviser wants to, or actually does act as a principal for its own account, or act as a broker for both a client and another person when effecting securities transactions, the adviser must; • Have the client’s consent • Disclose to all customers what capacity the adviser or brokerage firm is acting in. In other words, is the brokerage firm/investor adviser acting as a broker or as a dealer? In fact, the NASD has a similar rule. 2.3.4 Consent to Service of Process Broker-dealers, agents, investment advisers and investment adviser representatives obtain or renew their registration by filing an application and a consent of service to process with the Administrator. This form giving consent to service of process appoints the State Administrator to be the “attorney” for the registrant. In other words, if someone is making the registrant part of a lawsuit the opposing party need only serve the State Administrator with the notice of a law suit and it is the same as serving the adviser. This consent is not required for renewal applications. 2.4 INVESTMENT ADVISER REPRESENTATIVE 2.4.1 Definition of an Investment Adviser Representative An Investment Adviser Representative includes any partner, officer, director, or other individual associated with an investment adviser who; • Makes recommendations or renders advice regarding securities • Manages accounts or portfolios of clients

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Investment Advisor and Other Definitions

• Determines which recommendations or advice regarding securities should be given • Solicits, offers or negotiates the sale of investment advisory services • Supervises employees who perform any of the functions listed above • Note: An employee of an investment adviser whose job is only clerical or ministerial is NOT included in this definition. 2.4.2 Registration Requirements for Investment Adviser Representatives To get an effective registration, persons registering as an Investment Adviser Representative must be employed by an investment adviser. • Representatives of federally covered advisers must be registered in the state • Representatives of state covered advisers must be registered in the state • An investment adviser representative terminating employment must promptly notify the State Administrator • When an adviser representative begins or terminates employment with a state registered adviser, the investment adviser must promptly notify the Administrator. • Investment advisers cannot employ persons who have been suspended or barred in the industry. 2.4.3 Registration Standards for Agents and Investment Adviser Representatives • Requirement of passing a written examination (Series 63 for agents and Series 65 for Investment Advisers) • Investment adviser representatives must be employed through an investment adviser • Typically, agents and investment adviser representatives cannot be required to post a surety bond or net capital. HOWEVER, if they take custody of client’s funds and/or securities a surety bond and net capital requirement can be required by the State Administrator. 2.5 ONGOING REQUIREMENTS 2.5.1 Books and Financial Records Records relating to accounting, financial statements, trade tickets, customer account files, correspondence and any other records must be kept on file for a minimum time period of three years. However, if broker-dealers are required to

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maintain records by the SEC and/or NASD for a different number of years those rules take precedence over state rules. 2.5.2 Customer Reports State Administrators may require that investment advisers provide certain information to clients. This usually takes the form of an “Investment Advisory Brochure”. This brochure may satisfy all or part of the reporting requirements required by the State Administrators. This is required by the Investment Advisers Act of 1940 and any compliance to this Act satisfies any state requirements. The Brochure must be given to the prospective customers at least 48 hours prior to entering into any investment advisory contract. 2.5.3 Financial Reports Broker-dealers and investment advisors must file financial reports to the State Administrators as required. However if they are registered with the SEC then any reports filed under the Federal Acts will satisfy the state requirements. 2.5.4 Inaccurate Information If any reports are filed that contain any material incomplete or inaccurate information, then a correcting amendment must be filed promptly. If the corrected information is for an initial application the registration won’t become effective until 30 days after receipt of the amended registration. 2.5.5 Inspections All required records of registered broker-dealers and investment advisers are subject to periodic or special examination by representatives of State Administrators. State reviews can and are often coordinated with representatives of the SEC and NASD. 2.5.6 Broker Dealer Acting as an Investment Adviser A person is permitted to act as both a broker-dealer and an investment adviser without dual registration. However, Administrators may, in certain instances, stop a broker-dealer from transacting business as an investment adviser if they feel the person is not qualified. End of Chapter Two

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Section 2: Securities 15 Questions – 25% This section covers the definition of a security, sale, offer to sell, and issuer along with examples of what is and what is not a security, including Federal securities. The different types of registrations are reviewed along with any applicable exemptions.

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Definition and Examples

Chapter 3: Definition and Examples 3.1 DEFINITION OF A SECURITY The basic definition of a security is an investment in a common enterprise for profit, with management performed by another (third) party. If an offering meets the above definition it is a security under the Act and therefore would have to be registered in the state offered unless it is specifically exempt or excluded. 3.2 DEFINITIONS OF A SALE, AN OFFER TO SELL AND OFFER TO PURCHASE Sale: A contract to sell or dispose of a security or an interest in a security for value. Offer to Sell: Any attempt or offer to dispose of a security, or a solicitation of an offer to buy a security or an interest in a security for value. Offer to Purchase: An attempt or offer to obtain a security or a solicitation of an offer to sell a security or an interest in a security for value. The following would also constitute a sale or offer to sell a security; • Any security given as a bonus in conjunction with the purchase of a security • A gift of an assessable security (issuer can assess (charge) the owner for additional funds) • Sale or offer of a right, warrant or convertible security 3.2.1 Exclusions from the Definition • Stock dividends paid to shareholders • Security interest created as a result of a loan • Gift of a nonassessable security • Corporate reorganization caused by a merger, consolidation or sale of corporate assets

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3.3 OTHER DEFINITIONS Guaranteed: A guaranteed security is one in which the payment of principal, interest and/or dividends is guaranteed by a third party. Administrator: The USA is administered in each state by the State Administrator. State: A state is defined as any state, territory or possession of the United States, District of Columbia and Puerto Rico. Arbitrage: A transaction that results in a profit by buying one security, as an example, on the NYSE and selling it immediately on the Pacific Exchange for a profit. 3 . 4 TY P E S O F S E C U R I T I E S 3.4.1 Corporate Securities • Common stock, preferred stock, warrants and rights (Transferable shares) • Debt instruments such as bonds, debentures and notes • Treasury stock • American Depository Receipts (ADRs) • Equipment Trust Certificates (secured bond collateralized with some form of equipment) • Collateral Trust Certificates (secured bond collateralized with other securities such as stock) • Real Estate Investment Trust Certificates (secured bond collateralized with real estate and/or mortgages) • Collateralized Mortgage Obligations (CMO) (collateralized with mortgages such as GNMAs and FNMAs)‘ • Voting Trust Certificates (Special corporate securities used in corporate proxy fights) 3.4.2 Government Issues • U.S. Government obligations such as T-bills, T-notes and T-bonds. • U.S. Agency bonds such as GNMAs and FNMAs which are known as passthrough mortgage bonds • Obligations of States and Political Subdivisions like General Obligation (GO) and Revenue Bonds. • Foreign Government Bonds

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Definition and Examples

3.4.3 Options Clearing Corporation Issues • Call and put options which are option contracts with underlying securities such as equities, debt instruments and market indexes. 3.4.4 Investment Company Issues • Open-end fund shares, known as mutual funds. Shares are redeemable through the mutual fund company, not in the markets • Closed-end fund shares, commonly referred to as publicly traded shares. Therefore, they don’t get redeemed through the company but are negotiable and trade in the stock markets. • Unit Investment Trusts, known as UITs. They are similar to mutual funds but are not managed and would be redeemed. • Variable annuities are annuities in which the underlying securities are invested in the stock market. Choices of subaccounts similar to mutual fund investments are chosen by investors. • Investment Contracts known as front-end and spread-load contractual plans. 3.4.5 Tax Sheltered Issues • Limited Partnerships such as real estate, oil and gas drilling programs, cattle breeding and equipment leasing programs • A subscription agreement is filled out by the investor and sent to the General Partner with a check. Investors are not accepted until the General Partner approves and signs the subscription agreement • The accepted subscription agreement constitutes a certificate of interest in the partnership and is a security Test Clue: If the investor manages the partnership instead of the general partner, the operation would be considered a business and therefore NOT a security. 3.4.6 Other Issues Considered to be Securities • Whiskey warehouse receipts • Commodity options contracts • Merchandise marketing schemes such as multilevel distribution programs

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Definition and Examples

3.4.6.1 Issues Specifically Excluded form the Definition of Securities (State registration as a security is not required) • Insurance policies • Insurance endowment policies • Commodities futures contracts (remember, commodities option contract is considered a security because it is an option contract) • Interest in contributory or non-contributory retirement plans such as pension plans, Keogh (HR-10) plans, and IRAs. While these are NOT considered securities, the investment vehicles within them are securities. 3.5 ISSUER AND ISSUER RELATED DEFINITIONS Issuer: An issuer is any person who issues or proposes to issue a security. Corporation: An example would be PTS Inc. issuing a new bond issue. PTS is the issuer and the new bond would be the issue. Trust: Where there is no board of directors the issuer is defined as the person performing the function of a manager or depositor under the Trust agreement. Equipment Trust: The issuer is the person to whom the equipment is to be leased or conditionally leased to – which is generally the corporation. Issuer Transaction: The sale of securities is done for the benefit of the issuer as the issuer receives the proceeds from the transactions. This is an example of the Primary Market where a new issue stock is distributed by the issuer. Therefore, the transaction is known as a primary transaction. Another example of an issuer transaction is the redemption of mutual fund shares back to the mutual fund company. Payment is made from the issuer (mutual fund) to the shareholder. 3.6 DEFINITION OF A NON-ISSUER • Person not defined as an issuer • In a non-issuer transaction the proceeds from the sale of the securities go to someone other than the issuer such as in the Secondary Stock Markets. Here buyers and sellers are buying and selling between each other and the original issuer company does not receive any of the proceeds as it did in the primary market. This is also known as a Secondary Transaction.

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Definition and Examples

3.7 FEDERALLY COVERED SECURITIES Those securities identified as “federally covered securities” are securities but do NOT have to register in individual states where sold but do have to register with the Securities and Exchange Commission. 3.7.1 Some examples of Federally Covered Securities include; • Stocks listed on the exchanges or NASDAQ • Investment Company Issues registered under the Investment Company Act of 1940 • Securities of an issuer that are equal to or greater in seniority than a listed security • Securities offered or sold to qualified purchasers (as defined by the SEC) which is intended to emcompass sophisticated investors • Certain exempt securities, including government securities and some private placements. However, municipal securiteis are not covered securiteis with respect to ofers and sales within the issuer’s state 3.7.1.1 With Federally Covered Securities, States May NOT • Require registration or subject the offering to state review • Regulate any offering document prepared by or on behalf of the issuer 3.7.1.2 With Federally Covered Securities, States May • Require the issuer to file a notice, sales reports, and/or consent to service of process. This, however, does not include the NYSE, AMEX or Nasdaq NNM securities. • Require the payment of a registration fee despite the fact that the state may not require registration. This, however, soes not include the NYSE, AMEX or Nasdaq NNM securities • Investigate and bring enforcement actions regarding fraud, deceit, or unlawful conduct by a broker-dealer in connection with the sale of covered securities.

End of Chapter Three

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Registration of Securities

Chapter 4: Registration of Securities 4.1 REGISTRATION OF SECURITIES The Act states that it is unlawful for any person to offer or sell any security in a State unless the; • Security is registered in the States it is being sold in; or • Security is a federal covered security (registered under Federal Law); or • Security or transaction is exempt from registration Filing fees must accompany all registrations. If the fee is not paid in full the registration will be stopped or denied. The State Administrators can also require filing of any advertising or sales literature to be used in conjunction with the offering of the new security. Registration is effective for a period of one year. During this time period the State Administrator can require filing of quarterly status reports on the progress of the new offering. The registration application may only be made by the issuer or any person representing the issuer such as a broker-dealer selling shares or an officer of a company selling shares in a registered secondary offering. If the registration statement is incomplete or inaccurate, an amendment must be filed prior to the registration becoming effective. 4 . 2 TY P E S O F S E C U R I T I E S R E G I S T R A T I O N All securities that are classified as non-exempt (which means they are NOT exempt from registration) are required to be registered. The USA provides for the registration of securities by three methods. They are as follows; • Registration by Filing (Also known as Filing by Notification) • Registration by Coordination • Registration by Qualification 4.2.1 Registration by Filing (Also known as Notification) • This method can only be used by seasoned companies. This means that there must already be substantial trading activity and marketplace information available. This is a less rigorous registration method. • The issuer has been in business for at least 3 years.

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• A registration statement was filed under the Securities Act of 1933. • Company has timely filed all required reports with the SEC during the past 36 months. • The issuer must have a total net worth of $4,000,000 or a net pre tax income of $2,000,000 for 2 of the previous 3 years. • Must have at least 4 registered market makers making a market in the issuer’s equity securities for 30 days out of the preceding 3 months. • Underwriter commissions may not exceed 10% of the offering price of the security, and the minimum offering price is $5 per share. • Issuer cannot have defaulted in any payment of principal, interest, dividends or lease payments for the fiscal year preceding the registration filing. • The offering price of a new equity security must be $5 or more. 4.2.1.1 Open-end investment company, known as mutual funds or Unit Investment Trusts to register by Filing must; • Have a prior securities registration in the state within the previous 24 months. • Remain in compliance with all material terms of such prior registrations. • Have no material change in the terms of the issuer’s securities, method of selling securities, fund’s investment objectives or practices and the terms of sale of its securities. 4.2.1.2 Required Information for this Type of Registration • Filing a statement of eligibility for this type of filing. • Provide the name, address and form of business of the issuer. • Provide a description of the security being registered. • Provide a copy of a current prospectus on file for the security. Note: Registrations will be effective at the same time as the federal registration provided that no stop order is in effect, the required information and documents have been on file for at least 5 days, and the registration fee was paid. If the federal registration became effective at an earlier time, the state registration becomes effective when all required conditions are met. Registration by filing for mutual funds and unit investment trusts are effetive on the day the required information is filed with the Administrator.

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Registration of Securities

4.2.2 Registration by Coordination Under this registration method the issuer can coordinate State registration with an SEC registration being made under the Securities Act of 1933. Filing the SEC information with the State will satisfy state registration requirements. This is a more stringent rigorous method than Registration by Filing and can be used by any company filing a registration statement with the SEC. To register by Coordination, the issuer must file, in addition to the consent to service of process, the following with the State; • 3 copies of the current prospectus on file with the SEC • A copy of the Articles of Incorporation and By-Laws of the corporate issuer • A copy of any underwriter’s agreement • Copy of any indenture relating to the issuer • A specimen of the security to be issued • Any other information or documents requested by the State Administrator If no stop order is in effect, the State registration becomes effective when the Federal registration is effective. State Administrators require that an application be on file for a minimum of 10 business days before becoming effective. However, State Administrators can designate a shorter time period for the effective date. Many states have a 2 business day prior to the effective date minimum in effect. 4.2.3 Registration by Qualification A registration by qualification is the most difficult method of registering and can be used by any security in any state. 4.2.3.1 The required information to be filed is as follows; • General information such as the issuer’s name, address, type of organization, location, description of property and equipment and statement of competitive industry conditions. • Information on all officers and directors of the issuer, including earnings for each director for the past and current year. • Terms of the offering. • Information on all shareholders of 10% or more of the issuer’s securities. • Amounts paid to promoters and non-issuers in the past 3 years and proposed future payments. State Administrators can require stock given to promoters be held in escrow for up to 3 years after registration is effective to stop a promoter from immediately cashing out at a profit.

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• Current financial records to include an income statement, balance sheet and description of the issuer’s capitalization and long-term debt. • How sales proceeds will be used. • A copy of any prospectus, advertisement and sales literature related to the offering. • Description of any outstanding stock options. • All contracts made within the past two years and disclosure of any litigation. • Issuer’s Article of Incorporation and any trust indenture related to the securities offering. • Legal opinion and accountant’s opinion. • Any additional information required by the State Administrator. Test Clue: Registration becomes effective on a date determined by the Administrator. Normally this is 30 days after the date of filing, assuming there were no misstatements or omissions of material facts found. 4.2.4 General Rules Regarding Securities Registrations • All purchasers must receive the prospectus at or before the time an offer is made in writing or a written confirmation of a sale is sent. • Filing fees must be paid • Any unusual fees paid to promoters may be required to be deposited into an escrow account for up to 3 years • Registration is effective for 1 year from its effective date • Administrator may require the filing of quarterly reports by the issuer to disclose the progress of the offering 4.3 DENIAL, SUSPENSION AND REVOCATION OF REGISTRATION The Administrator has the power to issue a stop order denying effectiveness to registration, suspending registration or revoking registration of an issue if it is in the public’s best interest to do so and/or; • The registration statement is incomplete or contains false or misleading information concerning a material fact. • The Act has been willfully violated by any person involved in the offering. • The security is already subject to a stop order or injunction by another state or Federal court.

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Registration of Securities

• The issuer’s enterprise is illegal or tends to be fraudulent or deemed unfair or inequitable to the purchaser. • Underwriter’s compensation in the offering is unreasonable. • The issuer is ineligible for the registration method applied for or doesn’t meet the requirements. • Proper filing fees have not been paid. Note: An Administrator may not institute a stop order proceding against an effective registration statement on the basis of facts that were known to the Administrator when the registration statement became effective unless the proceedings are instituted within 30 days. Test Clue: If the Administrator issues a stop order the issuer must be given an opportunity for a hearing. The issuer must request a hearing within 15 days. If no hearing is requested then the order remains in effect.

End of Chapter Four

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Exempt Securities and Transactions

Chapter 5: Exempt Securities and Transactions 5.1 EXEMPT SECURITIES Securities that are exempt are exempted from both state registration requirements as well as advertising filing requirements. Even though a security may be exempt from registration requirements it is still subject to the Antifraud Provisions of the USA. The USA specifies the following as exempt securities; • Securities issued by the U.S. Government, any municipality or agency of the U.S. Government • Canadian and other foreign governments • Issues of banks, savings and loans, trust companies and federal credit unions • Insurance company issues (does not include variable contracts) • Securities issued by Railroads and Common Carrier regulated by the Interstate Commerce Commission • Public utility securities issued by the Public Utility Holding Act of 1935 • Any security listed on any exchange and the NASDAQ NMS system (This is known as the “Blue Chip Exemption”) • Issues of non-profit or charitable organizations and professional trade associations and cooperatives • Promissory notes that will mature in 270 days (9 months) or less that are rated in one of the 3 highest rating categories (i.e. AAA) and issued in amounts of at least $50,000. • Investment contracts issued in conjunction with employee stock purchase, profit sharing, pension or other employee benefit plans. 5 . 2 E X E M P T TR A N S A C T I O N S Exempt transactions are generally trades that do not involve the public. If a person offers a security in an exempt transaction then the issue does not have to be registered in that State. The exempt transactions under State law are; • Isolated non-issuer transactions: These are trades for the benefit of someone other than the issuer. Typically these transactions are limited to no more

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Exempt Securities and Transactions

than 5 trades within a 12 month period and the broker-dealer cannot be a resident of the state the trades are executed in. • Certain non-issuer distributions: This is normal secondary market trading of securities that have already been registered with the SEC. This exemption is not available for initial public offerings (IPO) as the issue must be in existence for at least 180 days. • Non-issuer transactions in outstanding securities of companies registered under the Investment Company Act of 1940: This is the normal secondary market trading of investment company securities that have already been registered with the SEC. • Unsolicited Transactions: Trades which are effected through a brokerdealer pursuant to unsolicited orders to buy or sell. • Fiduciary Transactions: Transactions made by executors, administrators, sheriffs, marshals, trustees in bankruptcies, guardians and conservators. • Transactions between issuers and underwriters: Exempt because the public is not involved. • Transactions with financial or institutional investors: Trades with banks, insurance companies, trusts, investment companies, pension funds and other institutions. • Private Placements: An offer made to no more than 10 persons in a 12 month period. Note that the Federal Regulation D private placement limits sales to 35 regular investors and to an unlimited number of accredited (more knowledgeable and/or wealthier) investors. • Offers or sales to existing shareholders where no commissions are paid • Sale of pre-organization subscriptions: Exempt if no commissions are paid for soliciting potential subscribers and the number of subscribers are limited to 10 persons. 5.3 REVOCATION OF AN EXEMPTION A State Administrator can deny or revoke the exemption for any security or transaction as long as prior notice is given to all interested parties, an opportunity for a hearing is provided and written findings and laws are provided. The Administrator may summarily deny or revoke any exemptions pending final determination of any proceeding. If a summary order is entered, the Administrator must; • Notify all interested parties with the reason for entering the order • Provide that a hearing be set within 15 days of receipt of a written request

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Exempt Securities and Transactions

• If no hearing is requested or ordered the summary order will remain in effect Test Clue: The burden of proving the existence of an exemption for any proceeding under the USA rests upon the person claiming the exemption.

End of Chapter Five

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Federal Covered Securities

Chapter 6: Federal Covered Securities 6.1 OVERVIEW Issues of federally traded securities are covered under federal rules that preempt states from regulating their public offerings, proxy solicitations and periodic disclosures. The USA defines federally covered securities as any of the following; • Securities listed on the New York Stock Exchange as well as other stock exchanges and the NASDAQ NMS (National Market System). • Investment company shares issued by a registered investment company under the Investment Company Act of 1940. • Securities that are offered or sold to qualified purchasers, which are defined by the SEC as being sophisticated investors. • Certain exempt securities and private placements. Test Clue: The Administrator cannot require registration of federally covered issues in the State. However, the Administrator can require, for the initial offering of securities in a State by an issuer; • A notice filing in the State • Filing with the State documents filed with the SEC along with a consent to service of process • Payment of filing fees in the State End of Chapter Six

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Section 3: Business Practices 21 Questions – 35% Business practices covers all fraudulent and dishonest business practices including illegal trade practices, compensation, handling of client securities, communications and more.

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Sales and Purchases

Chapter 7: Sales and Purchases 7.1 BACKGROUND According to the Uniform Securities Act (USA), which is the state act, it is unlawful for any “person”, in conjunction with any offer, sale or purchase of any security, directly or indirectly to do any of the following; • Employ any device, scheme or artifice to defraud • Make any untrue statement of a material fact or omit to state a material fact necessary to make a statement not misleading • Engage in an act, practice or course of business which operates or would operate as a fraud or deceit upon any person • Effect a transaction for a customer as a broker or a broker-dealer without obtaining the consent of the client. This amounts to unauthorized trading. • Engaging in any dishonest or unethical practice as the State Administrator may define by rule. • Engage in a pattern of unreasonable and unjustifiable delays in the delivery of securities purchased by any customer. As the language in this Act is written very broadly it is clearly understood that any conceivable action taken by a person can be considered to be fraud. In fact, the wording is close to the SEC “catch all” fraud rule. Under the USA, it is unlawful for any person who receives compensation, directly or indirectly, for advising as to the value of securities or their purchase, or sale including the use of analyses or reports to do any of the following; • Engage in any act, business or practice which operates as a fraud or deceit on any person such as representing that an agent’s or broker-dealer’s license means approval of the person’s activities and capabilities. • Make false or misleading statements with respect to the sale or purchase of a security such as: - Implying the SEC approved the security - Implying the SEC approved you as an agent - Implying the security is safe because it’s regulated by securities industry regulations - Indicating that a security will be listed on an exchange or the NASDAQ without knowing the information to be true

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Sales and Purchases

- Promising to perform free services which are not really free or there is a catch attached - Promising to perform services with no real intention to do so - Providing inaccurate market quotations - Misrepresenting or overstating a client’s account - Making exaggerated claims - Inaccurate statements as to the amount of commission or mark-ups being charged in a securities transaction - Spreading rumors or false statements with the intent of effecting a securities transaction - Incorrect statements of an issuer’s past earnings or future earning’s projections - Executing a transaction without authorization to do so. 7.2 FAILURE TO STATE IMPORTANT FACTS Just as important as making false or misleading statements, the USA also makes it illegal and a violation for omissions (leaving out) of material facts such as; • Failure to bring customers’ written complaints to your supervisor at the brokerage firm for resolution • Deliberately being selective in the information being provided to your client • Not disclosing to the client who prepared the research provided by your brokerage firm • Not notifying a client that a transaction will result with larger than normal commissions or transactions costs • Failure to disclose that the broker-dealer is controlled by an issuer of any security being offered to customers. 7.3 USE OF NON-PUBLIC INFORMATION Non-public or insider information is defined as any information that has not been disseminated to the general public. Non-public information is further defined as that information which has an effect on the value of a security, up or down. It is a violation of the USA to do any of the following; • Effect any transactions which are based on the use of material inside information

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• Pass on or transmit non-public information to anyone who might use it for trading purposes • Make recommendations to clients to either buy or sell securities which are based on material inside information • Inducing customers to trade based on hearsay or rumor because the truth of the information is not known. Test Clue: If you are in receipt of any inside information, no matter what the source, you should notify your immediate NASD registered principal. 7.4 SUITABILITY ISSUES Prior to making security recommendations to clients the registered representative must ensure that the elements of the securities recommended are suitable for those particular clients. Key suitability questions must be asked of the clients in reference to investment objectives, risk tolerance, investment experience, finances and more. The USA addresses violations of suitability rules and these violations are as follows; • Failure to inquire into a client’s financial situation, investment needs and investment objectives. • Engaging in transactions solely for the purpose of generating commissions (churning). • Recommending securities without regard to the customer’s financial situation or objectives. • Failure to disclose important facts concerning the risks of any recommended investments. • Recommending securities without having a reasonable basis for the recommendations. Even discretionary trades must be suitable. • Performing trades excessive in size in relation to the customer’s resources. 7.5 DISCLOSURE OF MATERIAL INFORMATION The USA specifically makes it unlawful to withhold material information from a client. A material fact is defined as one that would be essential in making an informed investment decision. Agents must not be selective in what investment information is given to customer. All material information must be communicated, not just the “good stuff”. After all, it takes an “informed client” to make appropriate investment decisions.

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7.6 OTHER PROHIBITED ACTS In addition to all the fraudulent acts previously mentioned, here are some more prohibited practices; • Guaranteeing a client’s account against losses or guaranteeing a profit • Borrowing money from a client • Commingling customer funds with agent funds or funds of a broker-dealer • Exercising discretion in a customer’s account without written authority • Deliberately failing to follow instructions from a client (e.g. client chooses a growth fund and you purchase an income fund instead) • Sharing in the profits or losses of a client’s account unless a joint account is opened with permission of the brokerage firm • Accepting orders for a client from a third party without obtaining a written third party trading authorization from the customer • Effecting private transactions with clients without the authority or permission of the agent’s broker-dealer. This is known in the NASD world as “selling away” • Soliciting orders for non-exempt unregistered securities. • Charging unreasonable and inequitable fees for services performed. • Splitting the agent’s commissions with any person not also registered as an agent for the same broker-dealer or for a broker-dealer under direct or indirect common control. • Establishing or maintaining an account containing fictitious information in order to execute transactions which would otherwise be prohibited. • Participating in manipulative market activities such as; - Giving fictitious quotes - Effecting “wash trades” (buying and selling securities to give the appearance of trading activities) - Effecting “matched orders” (trades that cancel each other but give the appearance of trading activity) - “Painting the Tape” (participating in securities transactions with the intention of giving the appearance of trading activity) - Disclosing information about a customer account to someone other than the customer, unless such disclosure is authorized by the client.

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• Not providing a prospectus required by the Securities Act of 1933. The prospectus must be given to a client prior to or at the time of solicitation. Test Clue: You are NOT permitted to mark up, highlight or underline a prospectus in any way to help point out important items to your clients. Making any marks on a prospectus is considered an amendment to the prospectus and is an SEC violation. 7.7 COMMUNICATING WITH CLIENTS 7.7.1 Advertising and Sales Literature The State Administrator may require advertising and sales literature to be filed with the State unless the security or transaction is exempt, or a federally covered security. Cannot use any advertising or sales presentations in such a fashion as to be deceptive or misleading such as distributing any nonfatal data or material. Included as advertising and sales literature are the following examples; • Circulars • Pamphlets • Form letters • Seminars 7 . 8 D E N Y, R E V O K E O R S U S P E N D R E G I S T R A T I O N Registration may be denied, suspended, or revoked if the Administrator finds that it is in the public interest and that the person who is the subject of the order; • Has filed a registration application that was materially incomplete, false or misleading. • The registrant has willfully violated the Act’s provisions. • Has not paid the required fees. • The registrant is subject to a State Administrator’s order denying, suspending or revoking the registration. • The State Administrator deems the applicant unqualified based on the level of experience, training, or securities knowledge. Test Clue: A State Administrator cannot use this point, by itself, to disqualify any new applicant as new persons are probably unqualified at this point. So, this requirement would be coupled with another requirement prior to any disqualification.

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• The registrant is deemed to be insolvent which is defined as the inability to meet obligations as they come due. • A court action has permanently or temporarily prohibited the registrant from engaging in the securities business. • Has engaged in unethical or dishonest business practices. • The registrant has been convicted (not just arrested)of a misdemeanor involving securities or has been convicted of any felony within the past ten (10) years. • Has failed to properly supervise employees. This provision applies to brokerdealers and investment advisers but does NOT apply to agents. • Been suspended or had its registration revoked by any State or the SEC within the past 10 years. Test Clue: The State Administrator is permitted to summarily postpone or suspend registration, pending a final determination. The applicant must be promptly notified and the applicant has 15 days from requesting a hearing on the action. If the applicant does not request a hearing within the 15 days, the order will stand until the State Administrator decides that it should be changed. 7.9 CANCELLATIONS AND WITHDRAWALS • Broker-dealers, investment advisers and agents can withdraw from registration voluntarily by submitting an application. The withdrawal becomes effective 30 days after the filing date. • If a broker-dealer or investment adviser loses its registration, all agents (registered representatives) and investment adviser representatives of that broker-dealer or investment advisers also will lose their registrations until they register and reinstate with another broker-dealer or investment adviser. • If legal proceedings are commenced within one year, registration cannot be withdrawn. This is done so that the State Administrator can maintain jurisdiction over those involved in a legal action. • Registration can be canceled if the State Administrator cannot locate any registered persons, find that a registered person has been declared incompetent or no longer in business. End of Chapter Seven Go to your Exam Review CD Rom Complete Business Practices

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Section 4 - Administrative Provisions and Other Remedies 6 Questions – 10% Administrative provisions and other remedies review the operating procedures for the administrator including investigations, issuing subpoenas and orders, jurisdiction, administrative actions, penalties, liabilities and other provisions.

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Powers of the Administrator, Liabilities and Penalties

Chapter 8: Powers of the Administrator, Liabilities and Penalties 8.1 POWERS OF THE ADMINISTRATOR • Conduct investigations • Issue subpoenas for persons and records (if not obeyed can be held in contempt of court) • Can publish information about violations • Can compel testimony that incriminates. However, individual can rely on their 5th Amendment right (Federal Law) against self-incrimination • Can issue an injunction or restraining order to cease and desist activities without conducting a hearing. Upon granting of an injunction or restraining order, a receiver or conservator may be appointed for either the defendant or the defendant’s assets. • Any person in disagreement with the final order of an Administrator may obtain a review in the appropriate court. Written petitions must be submitted within 60 days of the entry of the order. • If a violation took place in another State and proves a violation then this State can also take action. • The Administrator is empowered to deny, suspend or revoke any registration or registration statement if it is deemed to be in the public’s best interest and there is just cause in accordance with the Uniform Securities Act (USA). 8.2 CRIMINAL LIABILITIES AND PENALTIES Criminal liabilities exist if a person is found to have willfully violated any order or provision of the USA. A willful violation is classified as a felony under the Act. • Maximum penalty for each violation is a $5,000 fine and/or 3 years in prison. • The statute of limitations for these actions is five years from the date of the alleged violation. (Note: The amount of years can vary from state to state) • Restitution to the investor may also be required 8.3 CIVIL LIABILITIES UNDER THE ACT If the violation was not willful or intentional it is considered to be a Civil Violation, not a criminal violation. With civil liability the transaction is considered null and void. The main intent behind civil liabilities is that the customers get their

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investment dollars back. (Note: There is no such thing as civil penalties, only criminal penalties) 8.3.1 If the Investor Still Owns the Security If the investor still owns the investment purchased the customer is entitled to recover the following; • Original purchase price of the security, plus • Costs and reasonable attorney fees, plus • Interest on the money invested, computed from the purchase date, at the legal interest rate (most states use 6%), minus any income already received 8.3.2 If the Investor No Longer Owns the Security If the customer purchased the security in question but no longer owns it the customer is still entitled to recovery as listed above. Mathematically, the customer can recover the difference between the original price paid and the price at which the security was disposed of, plus interest paid at the legal rate, plus attorney’s fees, minus any income received from the security. If an investor purchased a security that was sold in violation of the Act, the investor is entitled to retain the profitable investments and still seek recovery as mentioned above for the unprofitable investments. 8.3.3 Transactions Where Civil Liability Applies Civil liabilities apply for the following violations; • Failing to register as an agent or broker-dealer • Selling unregistered securities in non-exempt transactions • Transactions that willfully manipulating the market • Failing to give a customer a prospectus where required • Failing to file sales literature and advertising as required • Misrepresenting the status of an agent’s or a security’s registration • Making unintentional false statements or omitting material facts Note: Any civil suits must be brought no later than 3 years after the contract of sale was executed. Such law suits cannot be brought later than 2 years after the discovery of the facts constituting the violation.

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Powers of the Administrator, Liabilities and Penalties

8.4 OFFER OF RESCISSION If a person realizes that they have effected an illegal securities transaction, they may, with a Letter of Rescission, offer to; • Provide a written explanation of the liability and advise the purchaser of his/ her right of rescission. • If the violation was caused by the omission of material information, any information necessary to correct the error must be furnished. • An offer to repurchase the security for cash in the manner previously discussed. • A statement that the offer must be accepted within 30 days. • No law suits are permitted by the investor if the right of rescission is not exercised by the client within 30 days of the written notice. 8.5 SCOPE OF THE ACT AND JURISDICTION 8.5.1 Scope of the Act The State Administrator is empowered by the USA to amend or rescind any rule that is deemed necessary to carry out the provisions of the Act. The only portion of the Act that the Administrator cannot change is the defined exempt securities such as U.S. Governments, Municipals etc. 8.5.2 Jurisdiction of the Administrator The USA gives the administrator jurisdiction over any offer to buy or sell (in writing or verbally) or any acceptance of the offer, when; • Either the agent or the client reside in the State • The transaction was effected in the State • The offer is directed from the State • The offer is directed into the State • An offer is accepted in the State 8.5.2.1 Interstate Rules and Problems There is reciprocity for the enforcement of subpoenas, but only if the activities for which the information is sought by another administrator would constitute a violation under this Act had the activities occurred in this State. If an out of state person refuses to produce documents or testify in this state, as an example, a court in this state can request an order to compel compliance from a court of another state able to assert jurisdiction over that person.

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Test Clue: When analyzing jurisdiction questions, the State that has original jurisdiction is the State that the “bad deed” was done in. Then all the other involved States get jurisdiction. 8.5.3 Jurisdiction over Offers Made in the Media An offer made in a newspaper with a general regular and paid circulation is not considered to be made in the State if: • The newspaper is not published in the State; or • If the newspaper is published in the State but has more than 2/3 of its circulation outside the State, during the last 12 months. Test Clue: Any offer to buy or sell securities made through television or radio that is broadcast in the State is not considered to be made in this State if the communication originates outside the State. • But, the broadcast is considered as having originated in this state if either the broadcast studio or the originating source of transmission is located in this state. 8.5.4 Situations to think about • If an offer originates in Wisconsin and is directed into Illinois, the offer is considered to be made in both states. • A person in Illinois makes an offer to buy as a result of an advertisement she sees in a paper published in Indiana) or seen/heard in a radio or television program originating in Indiana). If the seller in Indiana accepts the offer in Illinois the Administrator in Illinois would have original jurisdiction. • If a selling broker-dealer located in Illinois delivers a security into Florida, or the buyer in Florida sends a check in payment from within Florida, the Florida USA statute applies when delivery of the stock constitutes the seller’s acceptance of the buyer’s offer to buy. 8.5.4.1 Test Question Example: An agent registered in Illinois sells a security registered only in Wisconsin to a resident of Iowa. The sale takes place in Kentucky. Primary jurisdiction for any violations of the USA is that of the Administrator of the State of; A. Wisconsin B. Illinois C. Iowa D. Kentucky

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8.5.4.2 The Answer (D) The USA empowers an Administrator to take action against a person who violated the Act, if any activity that materially contributes to the violation occurs in his state. Here the jurisdiction is the state where the dastardly deed takes place... the state where the sale is made.

End of Chapter Eight

End of the Series 63 Content Review!

Go to your Exam Review CD Rom Complete Administrative Provisions Then complete the following on the CD: 1. Chapter Exams 2. Final Exams 3. “Timed State Exam”

Good luck! You will pass the Series 63!

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NASD Series 63 Important Terms

NASD Series 63 Important Terms Acting in a principal capacity: when a broker-dealer makes trades for its own account, thus bringing the security into its own inventory. Acting in an agency capacity: when a brokerage firm makes trades for the accounts of others and charges a commission. Agent: individual who represents a broker-dealer when performing securities transactions; basically a sales representative or registered representative of the broker-dealer. Arbitrage: a transaction that results in a profit or attempt to profit by exploring price differences of identical or similar investments on different markets or in different forms. Broker-dealer: a person who engages in the business of making securities transactions for the accounts of others or for its own account, known as propriety trading. Call and put options: option contracts with underlying securities such as equities, debt instruments and market indexes. Closed-end fund shares: commonly referred to as publicly traded shares; they are not redeemed through the company but are negotiable and trade in the stock markets. Collateral trust certificate: secured bonds backed up (collateralized) with some form of equipment or other securities. Collateralized mortgage obligations (CMOs): securities are backed up (collateralized) with mortgages such as Ginnie Maes and FNMAs. Debt instruments: the corporation is borrowing money, not selling part of the company by issuing stock; debt instruments include bonds, debentures and notes. Equipment trust certificate: secured bond collateralized with some form of equipment. Federally covered adviser (federally registered adviser): investment adviser that manages $25 million or more of assets or investment adviser to registered investment companies. Federally covered securities: securities which are NOT required to register in the individual states where sold; however, they must be registered with the Securities and Exchange Commission (SEC). Fiduciary transactions: transactions made by executors, administrators, sheriffs, marshals, trustees in bankruptcies, guardians and conservators.

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NASD Series 63 Important Terms

Guaranteed security: a security in which the payment of principal, interest and/or dividends is guaranteed by a third party. Investment Adviser: must register with states when providing for compensation, (1) investment advisory services to others as part of a financial planning practice, (2) advice, analysis or reports concerning securities or (3) these services in the regular course of their business. Investment adviser representative: includes any partner, officer, director or other individual associated with an investment adviser who (1) makes recommendations or renders advice regarding securities; (2) manages accounts or portfolios of clients; (3) offers, solicits or negotiates the sale of investment advisory services; (4) determines which recommendations or advice regarding securities should be given or (5) supervises employees who perform any of the functions listed above. Investment adviser contracts: must state the following three provisions: (1) investment adviser cannot assign the contract without the consent of the client; (2) investment adviser cannot be compensated on the basis of capital gains or capital appreciation of funds in the account unless the fee is based on the total value of all assets being managed and (3) if the investment adviser is a partnership, the client shall be notified within a reasonable time of any changes in the members of the partnership. Isolated non-issuer transactions: trades for the benefit of someone other than the issuer; typically these transactions are limited to five (5) trades within a 12month period and the broker-dealer cannot be a resident of the state in which the trades are done. Issuer: any person who issues or proposes to issue a security. Issuer transaction: the sale of securities is done for the benefit of the issuer. Matched orders: trades that cancel each other but give the appearance of trading activity. Non-issuer: any person not defined as an issuer. Non-issuer distribution: normal secondary market trading of securities that have already been registered with the SEC; exemption is not available for initial public offerings (IPOs) as the issue must be in existence for at least 180 days. Non-public or insider information: any information that has not been disseminated to the general public; information which has an effect on the up or down value of a security. Offer to purchase: an attempt to offer to obtain a security; a solicitation of an offer to sell a security or an interest in a security for value. Offer to sell: any attempt or offer to dispose of a security; a solicitation of an offer to buy a security or an interest in a security for value.

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NASD Series 63 Important Terms

Open-end fund shares (mutual funds): shares are redeemable through the mutual fund company, not in the markets. Painting the tape: participating in securities transactions with the intention of giving the appearance of trading activity (illegal). Person: includes corporations, associations, business trusts, partnerships, estates, political subdivisions of governments, joint ventures or joint stock companies, individuals and governments. Primary market: a new issue comes to market by the issuer and is known as a primary transaction. Real estate investment trust (REIT) certificates: bonds that are secured (backed up) with real estate and/or mortgages as collateral. Registration by Coordination: under this registration method the issuer can coordinate state registration with an SEC registration being made under the Securities Act of 1933; filing the SEC information with the state will satisfy state registration requirements; this is a more stringent, rigorous method than Registration by Filing and can be used by any company filing a registration statement with the SEC. Registration by Filing (Filing or Notification): this method can only be used by seasoned companies; there is substantial trading activity and marketplace information. Registration by Qualification: the most difficult method of registering and can be used by any security in any state. Sale: a contract to sell or dispose of a security or an interest in a security for value. Security: any legal instrument that indicates ownership or debt in a business, including negotiable and nonnegotiable instruments or contracts representing money or other property. Selling away: effecting private transactions with clients without the authority or permission of the agent’s broker-dealer. State: any state, territory or possession of the United States, the District of Columbia and Puerto Rico. State administrator: official in each state designated to administer, enforce and otherwise carry out the provisions of the state’s securities act. They examine the books and records of an issuer as often as necessary to guard against fraudulent practices. Treasury stock: common stock of a company that is being held by the company. When a company buys its own stock back this is called treasury stock.

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Unit investment trusts (UITs): similar to mutual funds but are not managed. Unsolicited transactions: trades made through a broker-dealer pursuant to unsolicited orders to buy or sell. USA: Uniform Securities Act (State Law) U.S. agency bonds: (e.g. Government National Mortgage Association (GNMA) and Federal National Mortgage Association (FNMA); known as pass-through mortgage bonds. Variable annuities: annuities that are invested in the stock market; choices of types of mutual fund investments are chosen by the investors. Voting trust certificates: special corporate securities used in corporate proxy fights.‘

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Professional Training Services, Inc. Series 6 & 63 TesTaker Program SECTION EXAMS FINAL EXAMS TIMED FINAL EXAM

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Installing the Program: After agreeing to the terms of CD Rom use, break the seal of the CD Rom plastic container and insert the CD into your CD drive. Note: The Series 63 data set is located on the CD Rom. You MUST keep the CD Rom in the CD Rom Drive at all times when running this program. Also, you have 150 days or 5 months to complete each program. The clock starts to run when you START using the Series 63 exam reviews program. Follow these steps to install and to use the exam review programs: 1. 2. 3. 4. 5.

Double-click on “My Computer.” Double-click on “Control Panel.” Double-click on “Add/Remove Programs.” Click the “Install” button. When the program directs you to insert the floppy disk or CD, click the “Next” button. 6. When the file “Setup.exe” appears in the command line, click the “Finish” button. Once the installation program begins, a box will appear stating that files are being copied. Please wait until this process is completed. When the necessary files are copied, a screen will appear advising you to close any open programs. This is a standard warning. Close any open programs and click the “OK” button. The next screen will allow you to specify where to install the program files. Unless you are familiar with specifying destination directories, it may be best to simply accept the default directory. Either way, to continue the installation by clicking the button with the picture of the computer. During the installation process, you may encounter some messages. Sometimes the installation program will advise you that a file is being copied that is not newer than the file that already exists on your computer. It will ask if you want to keep the existing file and suggest that you do so. You should keep the existing file by clicking the “Yes” button. In some rare instances, the setup program may need to update your system files, which will then require a reboot of the computer. If it so requests, it is safe to accept the update and allow the setup program to restart your computer. Once your computer has rebooted, you will need to restart the setup program, following the directions above.

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Starting the Program: The TesTaker program can be started by clicking on the “Start” button, then the “Programs” menu, then the “TesTaker” menu. A copyright screen will appear. Click the button labeled “Click Here” to commence the program.

Importing a Data Set: The first time the program starts, it will determine that no questions have yet been imported, and will display the following message:

To import questions, click the File menu, then the “Get Questions” menu. The following dialog box will appear: (This dialog box could say “My Documents”)

Click the down arrow to the right of the text box labeled “Look in” to navigate to your CD-ROM disk. (Usually Drive D or E with a picture of a CD Rom on the icon) On that disk, one or more files will appear that end in the “.set” extension. Click on a set file to select it, and then click the “Open” button to import the questions. Once the import process is completed, a message box will appear showing the total number of questions imported.

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The various tests and other menus will then be activated and you are ready to begin using the program. From time to time you may purchase additional data sets. You can load other data sets by following the same process listed above.

Taking Tests: You can take exams by clicking on the menu heading for the desired test, then click the desired test and the first question will appear. You answer the question by either clicking on the desired answer button or typing the letter A, B, C or D on your keyboard. When an answer is selected, the button graphic will change to either “Yes” or “No”. You can then select other choices to find the correct answer, but only your first response is counted toward your score. If and when the Explain button appears, it means that an explanation is available for that question and can be viewed by clicking on the button. During a test, you are able to skip a question by clicking on the “Skip” button. The question will then be skipped and will be brought back once you have completed the other questions. You can skip as many questions as you wish. Should you desire to exit the program prior to the completion of a test, you can do so by first clicking the “Exit Test” button. You will be asked to confirm your desire to exit the test prior to completion. You will then be offered the chance to save the test so that you will be returned to the same question the next time the program starts. If you save a test, the next time you start the program you will be given the opportunity to pick up where you left off.

Uninstalling TesTaker: Once you have successfully completed your actual licensing exam, you may wish to remove the TesTaker program from your computer. To do so: 1. 2. 3. 4. 5.

Double-click on “My Computer.” Double-click on “Control Panel.” Double-click on “Add/Remove Programs.” In the list of programs installed, click on TesTaker. Click the “Add/Remove” button.

The program will then be uninstalled from your system, releasing valuable hard drive space.

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Special Note: If you purchased more than one program you must follow the procedure mentioned in the “importing a data set” section once again. Make sure you are “pointing” to your CD Rom drive, not your C Drive. A warning will appear indicating that “prior questions will be deleted”. This DOES NOT delete anything from the CD Rom. It just deletes the current program questions such as the Series 63 from your computer’s memory in order to allow the new program to import the new questions. You can always go back to the former program by following the same procedure.

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Visit us at www.ptstraining.com Do your next insurance CE courses on the Internet and save * CFP Ethics Programs Workbook, On-line or Internet Download * NASD Firm Element Courses Registered Representative Tracking System * Other NASD Licensing Programs Available * Insurance Licensing and Continuing Education

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