marketing, prospecting and sales presentations 6+pdfs/s6_03.pdf · open- and closed-end mutual...

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Chapter Three

MARKETING, PROSPECTING, AND SALES PRESENTATIONS

OVERVIEW

This chapter will provide a description of regulation related to marketing and prospecting. More in-depth information will be provided regarding the Securities Act of 1933 and the contents of the prospectus. Additional FINRA Conduct Rules include Communication with the Public.

It is important to understand the difference between Institutional and Retail Communication. Rules and regulations that apply under the Securities Act of 1933 include regulation of the use of manipulative and deceptive devices. Sales practice rules will also be discussed which include general standards of business conduct, supervision, customer complaints, anti-money laundering compliance, and outside business activities of an associated person.

LEARNING OBJECTIVES

1. Defi ne the 4 types of prospectuses used in connection with offering securities for sale to the public

2. List 6 items that must be included in a mutual fund prospectus

3. Describe institutional and retail communications

4. Explain the general telemarketing requirements under the Telephone Consumer Protection Act

5. Identify the use of manipulative and deceptive devices

6. List the activities that require a fi rm to maintain an Offi ce of Supervisory Jurisdiction (OSJ)

7. Defi ne a private securities transaction

8. Defi ne selling compensation

Regulations Related To Marketing/Prospecting

3.1 Securities Act of 1933

Prospectus (Also known as an offer to purchase)A Prospectus is a formal legal document that provides necessary and material information about an investment offering for sale to the public. It is required by, and must be fi led with, the SEC.

It must contain the material facts that an investor needs to make an informed decision about the suitability of the security for the investor’s objectives. The prospectus must be given to potential investors of new issues of securities, including IPOs and other primary offerings for stocks, for all open- and closed-end mutual funds, and for variable insurance products. The prospectus is due to the customer at or before the time of the fi rst sales presentation.

Since open-end mutual funds are continually offering new shares to the public, a fund prospectus must be updated at least once every 16 months. Prospectuses are dated and only the most current prospectus may be given to the public. No prospectus can be used if it is more than 16 months old.

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Registration RequirementThe SEC requires that companies disclose important fi nancial and other information through the registration of securities. The information enables investors to make informed judgments about whether to purchase a company’s securities.

A security offered for sale must either be registered with the SEC or be lawfully exempt from registration.

There are several types of prospectuses used in connection with offering securities for sale to the public:

• Preliminary prospectus (also known as a red herring) is the fi rst informational document provided by a securities issuer. It includes some of the details of the business and proposed transaction, but it is not an “offer to sell.” This prospectus is designed to test whether there is any interest in the security. No security may be sold on the basis of a preliminary prospectus alone. It can contain an estimated price range, but not the offi cial price. It cannot contain an application to invest.

• Omitting prospectus states that a security can, or soon will, be available for sale. However, it does not provide the specifi c details that an investor needs to be able to make an informed purchasing decision. Like a preliminary prospectus, it is not an “offer to sell,” but it does include information on where or how to obtain a prospectus.

• Statutory or “full” prospectus is an “offer to sell” an initial public offering (IPO), a subsequent primary offering of securities, or mutual funds and variable insurance products, and can be circulated after the security is registered and approved for sale to the public. It also is referred to as a “fi nal prospectus” or “offering circular.” It supersedes the preliminary prospectus and includes details, such as:◦ Exact number of shares available◦ Where or how shares may be purchased◦ The offering price◦ All material fi nancial information concerning the issuer, its executive offi cers, and its board of

directors◦ An application to purchase

• Summary prospectus is an abridged form of the statutory prospectus that provides the essential information an investor would need to know to make a decision to buy. It includes an application to open a new account, and is thus an “offer to sell.”

Open-end mutual funds, which continuously offer new shares for sale to the public, issue a statutory prospectus and a summary prospectus. The broker-dealer may provide the customer with only the summary prospectus as long as the full prospectus is available online or sent to the investor with the confi rmation of the trade.

Statement of Additional Information (SAI, also known as “Part B” of the fund’s registration statement)An SAI is a supplementary document to a mutual fund prospectus that contains additional information about the fund. It includes additional disclosures regarding its operations that are not necessarily needed by an investor to make an informed investment decision.

The prospectus by itself provides enough information to make an informed decision, but the SAI provides details some investors would fi nd of critical importance. While a statutory prospectus might be 30-40 pages long, by comparison, an SAI might be 200-300 pages long.

Availability Requirements – SAI must be sent to investors within 3 business days upon request and without charge.

MARKETING, PROSPECTING, AND SALES PRESENTATIONS – CHAPTER THREE

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Contents of the ProspectusA mutual fund prospectus must contain the following items:

• Its objectives• Investment strategies• Risk exposures• Historical performance (1-, 5-, and 10-years, or lifetime if less)• Distribution policy• Fees and expenses for each class of shares:

◦ Front end sales charge or “load"◦ Contingent deferred (back end) sales charge◦ 12b-1 fee◦ Redemption fee, if any ◦ Management fee◦ Other expenses

• Expense Table – Includes reduced sales charges available through breakpoints, rights of accumulation, combination of accounts, and letter of intent.

• Exchange privileges within family of funds• Sales/Redemptions

◦ Per-share income and capital changes◦ Methods of sale◦ Methods of redemption◦ Investment and withdrawal plans

• Financial Statements• Fund management

Prohibitions Relating to Interstate Commerce and the MailsSales materials cannot go across state lines unless a prospectus accompanies the material.

Civil Liabilities Arising in Connection with Prospectuses and Communications The person who purchases a security has the right to pursue civil tort claims if the items in the fi ling statements include false statements regarding material facts or omit material facts required to be stated.

Fraudulent Interstate Transactions It is unlawful to engage in securities fraud across state lines.

Unlawful Representation SEC “No Approval” Clause The SEC does not:

• Warrant the accuracy of the registration statement• Pass any judgment on the quality of the investment

It is unlawful to say or imply that the SEC approves of any investment; this disclaimer must be at the front of every prospectus.


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Rules Related To Sales Presentations/Materials

3.2 FINRA Conduct Rules

Communications with the Public FINRA Rule 2210Defi nitionsInstitutional Communication – Any printed or electronic communication which is directed only to institutional investors. Such investors include banks, trust companies, insurance companies, investment companies, employee benefi t plans with at least 100 participants, government entity, investment advisers, and other broker/dealers and registered persons. This communication includes printed media and also all websites, emails, texts, and faxes.

Retail Communication – Any printed or electronic communication which is directed to more than 25 retail investors in any 30 calendar day period. A retail investor is any party other than an institutional investor, whether the person maintains an account with the broker/dealer or not. All individuals, including accredited individuals, are considered retail investors.

NOTE: Generally what was formerly considered “advertising” and “sales literature” is now classifi ed as retail communication.

Correspondence – Consists of any written or electronic communication directed to 25 or fewer retail investors in a 30 calendar day period. This includes customers and prospective customers.

Example: A single email distributed to 10 clients or prospects is correspondence. A single email sent to more than 25 clients or prospects is retail communication.

In addition to the 3 major categories of communication (i.e., Institutional, Retail, and Correspondence), there are also other types, as listed below:

Research Report – Information compiled by an analyst associated with an investment bank or broker/dealer which focuses on specifi c securities or on market sectors and may contain specifi c or nonspecifi c buy, sell, or hold recommendations.

Public Appearance – Any participation in a seminar, forum (including an interactive electronic forum), radio or television interview, or other public appearance or public speaking activity.

Independently Prepared ReprintAny reprint or excerpt of any article issued by a publisher, provided that:

• The publisher is not an affi liate of the member using the reprint or any underwriter or issuer of a security mentioned in the reprint.

• Neither the member using the reprint nor any underwriter or issuer of a security mentioned therein has commissioned the reprint.

• The member using the reprint has not materially altered its contents except as necessary to make the reprint consistent with applicable regulatory standards or to correct errors.

It's also any report concerning an investment company registered under the Investment Company Act of 1940, provided that:

• The report is prepared by an entity that is independent of the investment company, its affi liates, and the member using the report (the “research fi rm”).

• The report’s contents have not been materially altered by the member.• The research fi rm prepares and distributes reports based on similar research with respect to a

substantial number of investment companies.


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• The research fi rm updates and distributes reports based on its research of the investment company with reasonable regularity in the normal course of the research fi rm’s business.

• Neither the investment company, its affi liates, nor the member using the research report has commissioned the research used by the research fi rm in preparing the report.

• If a customized report was prepared at the request of the investment company, its affi liate or a member, then the report includes only information that the research fi rm has already compiled and published in another report, and does not omit information in that report necessary to make the customized report fair and balanced.

Approval and Recordkeeping Generally Applicable to Member Firms

Registered Principal Approval Retail communication must be approved by a principal before the earlier of its fi ling with FINRA or fi rst use. Correspondence and institutional communication can be approved by a principal before or after use. If the broker/dealer permits post approval, it must have an adequate, documented training program addressing correspondence.

Independently prepared reprints, research reports, and public appearances can be approved by a principal after fi rst use.

FINRA ApprovalRetail communication must be:

• Pre-fi led with FINRA at least 10 days before fi rst use when used by a new broker-dealer or any broker-dealer which has never fi led retail communication before

• Filed no later than ten days after fi rst use when used by a broker-dealer who has been fi ling communication for at least one year

These communications are subject to spot check by FINRA for 3 years from last use.

RetentionBroker-dealers must retain copies of all retail communication, institutional communication, correspondence, independently prepared reprints, research reports, and scripts of public appearances for three years after last use.

Telemarketing – General Telemarketing Requirements and the Telephone Consumer Protection Act (TCPA) of 1991No member or person associated with a member can initiate any telephone solicitation in violation of the following standards:

Time of Day RestrictionAny residence of a prospective customer before 8 a.m. or after 9 p.m. (the prospect’s local time), unless:

• The member has an established business relationship with the person.• The member has received that person’s prior express invitation or permission.• The person being called is a broker dealer.

Firm-Specifi c Do-Not-Call List – Any person who previously stated that he/ she does not wish to receive an outbound telephone call made by or on behalf of the member.

National Do-Not-Call List – Any person who has registered his or her telephone number on the Federal Trade Commission’s national do-not-call registry.


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• Exceptions – A member making telephone solicitations will not be liable if:◦ Established Business Relationship Exception – The member has an established business

relationship with the recipient of the call.◦ Personal Relationship Exception – The associated person making the call has a personal

relationship with the recipient of the call.

NOTE: Not-for-profi t organizations are exempt from the requirements of these rules. These rules also don't apply to customer service divisions, technical support services, or toll-free assistance (800 number) departments.

• Safe Harbor Provision – A member or person associated with a member making telephone solicitations will not be liable if the member or associate demonstrates that the violation is the result of an error and that as part of the member’s routine business practice, it meets the following standards:◦ Written Procedures – The member has established and implemented written procedures to

comply with the national do-not-call rules.◦ Training of Personnel – The member has trained its personnel, and any entity assisting in its

compliance, in procedures established pursuant to the national do-not-call rules.◦ Recording – The member has maintained and recorded a list of telephone numbers that it

cannot contact.◦ Accessing the National Do-Not-Call Database – The member uses a process to prevent

telephone solicitations to any telephone member on any list established pursuant to the do-not-call rules, employing a version of the national do-not-call registry obtained from the administrator of the registry no more than 31 days prior to the date any call is made, and maintains records documenting this process.

Procedures – Prior to engaging in telemarketing, a member must institute procedures to comply. Such procedures must meet the following minimum standards:

• Written Policy – Members must have a written policy for maintaining a do-not-call list.• Training of Personnel Engaged in Telemarketing – Personnel engaged in any aspect of

telemarketing must be informed and trained in the existence and of the do-not-call list.• Recording, Disclosure of Do-Not-Call Requests – If a member receives a request from a person

not to receive calls from the member, the member must record the request and place the person’s name, if provided, and telephone number on the fi rm’s do-not-call list at the time the request is made.

Members must honor a person’s do-not-call request within a reasonable time from the date such request is made. This period may not exceed 30 days from the date of such request.

If such requests are recorded or maintained by a party other than the member on whose behalf the telemarketing call is made, the member on whose behalf the telemarketing call is made will be liable for any failures to honor the do-not-call request.

• Identifi cation of Sellers and Telemarketers – A member or person shall provide the called party with the name of the individual caller, the name of the member, and address or telephone number at which the member may be contacted, and disclose that the purpose of the call is to solicit the purchase of securities or related service.

• Affi liated Persons or Entities – In the absence of a specifi c request by the person to the contrary, a person’s do-not-call request shall apply to the member making the call, and will not apply to affi liated entities unless the consumer reasonably would expect them to be included given the identifi cation of the caller and product being advertised.

• Maintenance of Do-Not-Call Lists – A member making calls for telemarketing purposes must maintain a record of a caller’s request not to receive further telemarketing calls. A fi rm specifi c do-not-call request must be honored for 5 years from the time the request is made.


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Wireless Communication – The provisions set forth in this rule are applicable to members who are telemarketing or making telephone solicitations calls to wireless telephone numbers.

Outsourcing Telemarketing – If a member uses another entity to perform telemarketing services on its behalf, the member remains responsible for ensuring compliance with all provisions contained in this rule.

3.3 Rules and Regulations under the Securities Act Of 1933

Generic Retail CommunicationThis is a notice, circular, advertisement, letter, sign, or other communication published or transmitted to any person. It does not specifi cally refer to:

• The securities of a particular investment company• The investment company itself• Any other security that is not an exempt security. Such communication will not be deemed to offer

any security for sale, provided such communication is limited to any one or more of the following:◦ Explanatory information relating to:

▪ Securities of investment companies generally, or▪ To the nature of investment companies, or ▪ Services offered in connection with the ownership of such securities.

◦ The mention or explanation of investment companies of different generic types or having various investment objectives, such as balanced funds, growth funds, income funds, leveraged funds, specialty funds, variable annuities, bond funds, and no-load funds.

◦ Offers, descriptions, and explanations of various products and services not constituting a security subject to registration under the Act, provided that such offers, descriptions, and explanations do not relate directly to the desirability of owning or purchasing a security issued by a registered investment company.

◦ Invitation to inquire for further information.◦ The communication contains the name and address of a registered broker-dealer or other entity

sponsoring the communication.

If this communication contains a solicitation of inquiries and prospectuses for investment company securities that are to be sent or delivered in response to such inquiries, then the number of such investment companies and, if applicable, the fact that the sponsor of the communication is the principal underwriter or investment adviser for the investment companies must be stated.

With respect to any communication describing any type of security, service, or product, the broker/dealer or other person sponsoring such communication must offer for sale a security, service, or product of the type described in such communications.

Investment Company Retail Communication It is unlawful for any person to, directly or indirectly, to communicate information that is materially misleading in connection with the offer or sale of securities issued by an investment company.

Retail communication is materially misleading if it:

• Contains an untrue statement of a material fact, or• Omits a material fact necessary in order to make a statement made, in the light of the circumstances

of its use, not misleading


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Whether or not a particular description, representation, illustration, or other statement involving a material fact is misleading depends on the evaluation of the context in which it is made. In considering whether a particular statement involving a material fact is or might be misleading, weight should be given to all pertinent factors, including, but not limited to, the following:

• A statement could be misleading because of:◦ Other statements being made in connection with the offer of sale or sale of the securities in question◦ The absence of explanations, qualifi cations, limitations or other statements necessary or

appropriate to make such statement not misleading; or◦ General economic or fi nancial conditions or circumstances

• Representations about past or future investment performance could be misleading because of statements or omissions made involving a material fact, including situations where:◦ Portrayals of past income, gain, or growth of assets convey an impression of the net investment

results achieved by an actual or hypothetical investment that would not be justifi ed under the circumstances, including portrayals that omit explanations, qualifi cations, limitations, or other statements necessary or appropriate to make the portrayals not misleading.

◦ Representation, whether expressed or implied, about future investment performance, including:▪ Representations as to security of capital, possible future gains or income, or expenses

associated with an investment▪ Representations implying that future gain or income may be inferred from or predicted

based on past investment performance; or▪ Portrayals of past performance, made in a manner which would imply that gains or income

realized in the past would be repeated in the future• A statement involving a material fact about the characteristics or attributes of an investment

company could be misleading because of:◦ Statements about possible benefi ts connected with or resulting from services to be provided or methods of

operation that do not give equal prominence to discussion of any risks or limitations associated therewith◦ Exaggerated or unsubstantiated claims about management skill or techniques, characteristics

of the investment company or an investment in securities issued by such company, services, security of investment or funds, effects of government supervision, or other attributes; and

◦ Unwarranted or incompletely explained comparisons to other investment vehicles or to indexes

Retail communication includes any communication (whether in writing, by radio, or by television):

• Used by any person to offer to sell or induce the sale of securities of any investment company• Communications between issuers, underwriters, and dealers are included in this defi nition of sales

literature if such communications can be reasonably expected to be communicated to prospective investors or are designed to be employed in either written or oral form in the offer or sale of securities.

Further Rules Regarding Investment Company Retail Communication All retail communication with respect to securities of an investment company registered under the Investment Company Act of 1940, or a business development company that is selling or proposing to sell its securities pursuant to a registration statement that has been fi led under this act is also subject to the following rules.

Required DisclosureThe following describes the information that is required to be included in retail communication in order to comply with this section.


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Availability of Additional Information – Retail communication must include a statement that:

• Advises an investor to consider the investment objectives, risks, charges, and expenses of the investment company carefully before investing

• Explains that the prospectus contains these and other information about the investment company• Identifi es where an investor can obtain a prospectus• States that the prospectus should be read carefully before investing

Even if used with a Profi le, all of the previous information applies.

Retail Communication used Prior to the Effective Date of the Registration StatementRetail communication that is used prior to the effective date of the investment company’s registration statement, or the determination of the public offering price (in the case of a registration statement that becomes effective omitting information from the prospectus contained in the registration statement), must include the “Subject to Completion” legend on the outside front cover page of the prospectus or Statement of Additional Information, a prominent statement that:

• The information in this prospectus (or Statement of Additional Information) is not complete and may be changed.

• These securities cannot be sold until the registration statement fi led with the Securities and Exchange Commission is effective.

• This prospectus (or Statement of Additional Information) is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is prohibited.

Performance DataRetail communication that includes performance data of an open-end management investment company or a separate account registered under the 1940 Act as a unit investment trust offering variable annuity contracts (trust account) must include the following:

• A legend disclosing that:

◦ The performance data quoted represents past performance.◦ Past performance does not guarantee future results.◦ The investment return and principal value of an investment will fl uctuate so that an investor’s

shares, when redeemed, may be worth more or less than their original cost.◦ Current performance may be lower or higher than the performance data quoted. ◦ Must identify either a toll-free (or collect) telephone number or a website where an investor may

obtain performance data current to the most recent month-end unless the advertisement includes total return quotations current to the most recent month ended 7 business days prior to the date of use.

◦ An advertisement for a money market fund may omit the disclosure about principal value fl uctuation.

• If a sales load or any other nonrecurring fee is charged, the maximum amount of the load or fee must be included. If the sales load or fee is not refl ected in the performance data included in the retail communication, a statement must be included indicating that the performance data do not refl ect the deduction of the sales load or fee and that the performance data would be lower if a load or fee were included.


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Money Market FundsRetail communication for an investment company that holds itself out to be a money market fund must include the following statements:

• An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency.

• The fund seeks to preserve the value of the investment at $1.00 per share. A money market fund that does not hold itself out as maintaining a stable net asset value may omit this statement.

• It is possible to lose money by investing in the fund.

PresentationIn printed retail communication, the post-performance data legend must be prominently presented in a type size at least as large as and of a style different from, that used in the major portion of the communication. When performance data is presented in a type size smaller than that of the major portion of the communication, the statements required must appear in a type size no smaller than that of the performance data.

If retail communication is delivered through an electronic medium, the legibility requirements for the statements required of this section relating to type size and style must be satisfi ed by presenting the statements in any manner reasonably calculated to draw investor attention to them.

In a radio or television communication, the statements required of this section must be given emphasis equal to that used in the major portion of the advertisement.

The statements required of this section must be presented in close proximity to the performance data and, in a print advertisement, must be presented in the body of the communication and not in a footnote.

Commission LegendRetail communication that complies with the minimum standards need not contain the Commission legend.

Use of Applications Retail communication that complies with this section cannot contain or be accompanied by any application that would allow a prospective investor to invest in the investment company.

Variable Annuity and Variable Life Insurance ContractsA prospectus, by which a unit investment trust offers variable annuity or variable life insurance contracts, can contain a contract application. The prospectus includes information about an investment company in which the unit investment trust invests.

• Profi le – Retail communication that complies with this section may be used with a Profi le that includes, or is accompanied by, an application to purchase shares of the investment company.

Performance Data for Non-Money Market FundsIn the case of an open-end management investment company or a trust account (other than a money market fund), any quotation of the company’s performance contained in a retail communication must be limited to quotations of:

• Current yield• Tax-equivalent yield• Average annual total return, showing 1-year, 5-year and 10-year periods. If a fund is open less than

10 years, it must show “life of fund” (aka: “since inception”). Any time frames over 10 years must be denoted in 5 year increments or show the life of the fund.

• After-tax return


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• Other performance measures• Performance data for money market funds• Total Return (showing 1-year, 5-year and 10-year periods. If fund is open less than 10 years, it must

show “life of fund.” Any time frames over 10 years must be denoted in 5 year increments or show the life of the fund.

• Communications that make tax representations • Timeliness of performance data• The total return quotations are current to the most recent month ended 7 business days prior to the

date of use of the advertisement

3.4 Rules and Regulations under the Securities Act Of 1933

Regulation of the Use of Manipulative and Deceptive DevicesIt is unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange:

• To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale of any security registered on a national securities exchange, in contravention of such rules and regulations or appropriate in the public interest or for the protection of investors

• To use any manipulative or deceptive device or contrivance in contravention of such rules and regulations or appropriate in the public interest or for the protection of investors

• Rules prohibit fraud, manipulation, or insider trading

NOTE: This section does not apply to security futures products.

Employment of Manipulative and Deceptive Devices by Brokers/Dealers It is unlawful for any broker-dealer or municipal securities dealer to use any manipulative, deceptive or other fraudulent device (as defi ned by the SEC) in connection with the purchase or sale of any security.

Furthermore, the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange, can't be used to communicate any such information.

3.5 Investment Company Act of 1940 and Rules Thereunder

Periodic and Other ReportsSales Literature Deemed to Be Misleading Any retail communication addressed to or intended for distribution to prospective investors that is required to be fi led with the administrator by the Act must state the facts necessary in order to make the statements made not materially misleading.

Periodic and Other ReportsA materially deceptive and misleading name of a fund includes Names suggesting:

• Guarantee or approval by the United States government• Investment in certain investments or industries in which the fund has not invested

Geographical FocusA name suggesting that the fund focuses its investments in a particular country or geographic region is not allowed, unless the fund has adopted a policy to invest, under normal circumstances, at least 80% of the value of its assets in investments that are tied economically to the particular country or geographic region suggested by its name.


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Tax-Exempt FundsIn order to call a fund "tax exempt," at least 80% of its investments must be in tax exempt vehicles. For example, 80% of the investment must be municipal bonds that are federally tax exempt and, depending on the state where the investor lives, also exempt from state taxes. So, it is a naming convention rule wherein over 80% of the investment must be invested in whatever the name implies. Another example would be if there was a capital appreciation fund, 80% of the investment must be in common stocks that have the potential to appreciate in value.

Sales Practice Rules

3.6 General Standards of Business ConductFront Running Policy prohibits the practice of a member fi rm or associated persons buying or selling on information obtained from the fi rm’s underwriters or from the fi rms trading desk before clients have a chance to execute orders of the security.

3.7 Standards of Commercial Honor and Principles, and Principles of Trade A member, in the conduct of its business, must observe high standards of commercial honor and just and equitable principles of trade.

3.8 Use of Manipulative, Deceptive or Other Fraudulent Devices No member can effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.

3.9 Supervision

Member fi rms are required to maintain a supervisory system for their registered representatives.Written procedures must be created to ensure oversight of the representatives’ activities in handling customer accounts.

Members must conduct internal inspections at least once a year to ensure compliance with securities laws, and these inspections must include a review of customer account records to detect irregularities and ensure compliance.

Branch offi ces must have a registered principal to supervise representatives. Each registered representative must participate in a meeting with a designated supervisory person to discuss compliance matters.

All transactions and correspondence related to solicitation must be reviewed and given written approval by a registered principal.

Member fi rms must maintain an Offi ce of Supervisory Jurisdiction (OSJ) for any offi ce location where the following activities occur:• Approval of new accounts• Approval of advertising• Order execution• Custody of customer funds or securities• Review of customer orders


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Supervision of registered representatives includes the following issues:• Qualifi cations Investigated – Members must investigate the good character, business reputation,

qualifi cations and experience of any person prior to making such a certifi cation in the application of such person for registration.

• Notice of Outside Employment – The representative must provide written notice to the member fi rm before taking on any outside employment or business activity in order to ensure no confl ict of interest arises.

• Regulation of Securities Transactions – The member fi rm must be notifi ed of any account opened for the representative at another securities fi rm, and can request duplicate account statements. Also, the representative must not participate in any private securities transactions without prior written notice to the employer. An exception to this rule exists for mutual fund accounts and variable contracts registered under the Investment Company Act of 1940.

3.10 Networking Arrangements Between Members and Financial InstitutionsWhen a broker-dealer has an agreement with a bank or other fi nancial institution whereby that institution refers its customers to the broker-dealer for securities business, there must be a written contract outlining the responsibilities of both parties and how each will be compensated. This contract must also state that SEC and FINRA personnel may enter the fi nancial institution’s premises to inspect all books and records concerning the broker-dealer activity. The broker-dealer must promptly notify the fi nancial institution whenever a registered representative employed by the fi nancial institution is terminated for cause by the broker-dealer.

If the broker-dealer operates from a location on the premises of the institution, the broker-dealer’s space must be clearly separate from the fi nancial institution. This space must also clearly display the broker-dealer’s name and SIPC membership sign.

Any retail communication that promotes broker-dealer services in conjunction with the fi nancial institution or on that fi nancial institution’s premises must disclose that the securities products are:

• Not FDIC insured• Not deposits or otherwise obligations of the fi nancial institution, nor are they guaranteed by the

institution• Subject to investment risk, including possible loss of principal

Retail communications that aren't required to contain these three disclosures are:

• Electronic signs• Time and temperature signs• Ticker tape signs• Banners showing location only• Radio broadcasts not exceeding 30 seconds

When a broker-dealer opens an account with a referred customer of the fi nancial institution, the registered representative must make these same three disclosures orally and in writing at or prior to the opening of the customer account. In addition, the registered representative must make every effort to get a signed acknowledgement of these disclosures from the new customer. However, obtaining a signed customer acknowledgement is NOT required.


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3.11 Customer Complaints Each OSJ must maintain records of customer complaints for a minimum of 4 years, including complaints dealing with activities supervised from that offi ce. Records can be kept at the home offi ce of the OSJ as long as they are readily available.

Complaints consist of any written statement of a customer or any person acting on behalf of a customer alleging a grievance involving the activities of those persons under the control of the member in connection with the solicitation or execution of any transaction or the disposition of securities or funds of that customer.

3.12 Investor Education and ProtectionOn an annual basis, broker-dealers must provide each customer with the following information:

• FINRA’s BrokerCheck Hotline Number• FINRA’s website address• A statement that the investor brochure describing FINRA BrokerCheck is available.

This information may be furnished to the customer in writing or electronically.

3.13 Anti-Money Laundering Compliance Program The Bank Secrecy Act requires that each member fi rm must:

• Establish and maintain procedures that will detect money laundering• Establish and maintain policies to comply with the Bank Secrecy Act• Test for compliance with the program• Designate an anti-money laundering contact to FINRA, who is responsible for its anti-money laundering

program• Provide on-going training to the fi rm’s personnel

3.14 Outside Business Activities of an Associated Person No person associated with a member in any registered capacity can be employed by, or accept compensation from, any other person as a result of any business activity, other than a passive investment, outside the scope of the relationship with the employer fi rm.

However, this is permitted if he/she has provided prompt prior written notice to the member fi rm. The member fi rm can prohibit the activity if the fi rm determines that the outside business activity could create a confl ict of interest.

NOTE: The only requirement imposed on a registered representative is to provide “prior written notice” before engaging in any outside business activity. The RR does not need to wait for approval, but must terminate such activity if the fi rm disapproves. However, activities involving “selling away” always require prior approval before a RR may engage in such outside business activity.

3.15 Private Securities Transactions of an Associated Person (“Selling Away”)

Defi nitionsPrivate Securities Transaction – Any securities transaction outside the regular course or scope of an associated person’s employment with a member fi rm, including, though not limited to:

• New offerings of securities that are not registered with the Commission• Transactions among immediate family members for which no associated person receives any selling

compensation• Personal transactions in investment companies and variable annuity securities are excluded


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Selling Compensation – Any compensation paid directly or indirectly from whatever source in connection with or as a result of the purchase or sale of a security, including, but not limited to:

• Commissions• Finder’s fees• Securities or rights to acquire securities• Rights of participation in profi ts, tax benefi ts, or dissolution proceeds, as a general partner or

otherwise; or expense reimbursements.

ApplicabilityNo person associated with a member shall participate in any manner in a private security transaction without prior written approval by the member fi rm.

Written Notice Prior to participating in any private securities transaction, an associated person must provide written notice to the member fi rm with whom he/she is associated describing in detail the proposed transaction and the person’s proposed role therein. The notice also must state whether the person has received or might receive selling compensation in connection with the transaction.

In the case of a series of related transactions with relatives of the associated persons in which no selling compensation has been or will be received, an associated person can provide a single written notice.

Transactions for Compensation In the case of a transaction in which an associated person has received or might receive selling compensation, a member that has received notice must in writing advise the associated person, stating whether the member approves or disapproves the person’s participation in the proposed transaction.

If the member approves a person’s participation in a transaction, the transaction will be recorded on the books and records of the member. The member will supervise the person’s participation in the transaction as if the transaction were executed on behalf of the member fi rm.

If the member disapproves a person’s participation, the person must not participate in the transaction in any manner, directly or indirectly.

Transactions not for Compensation In the case of a transaction or a series of related transactions in which an associated person has not and will not receive any selling compensation, a member fi rm must provide the associated person prompt written acknowledgment and can, at its discretion, require the person to adhere to specifi ed conditions in connection with his/her participation in the transaction.

3.16 Recording of ConversationsWhenever a broker-dealer’s sales force contains a specifi ed percentage of registered representatives who were formerly employed at a broker-dealer who was expelled from membership in an SRO or whose SEC registration was revoked, this broker-dealer must tape record all conversations by its entire sales force. This specifi ed percentage ranges from 20% for a small broker-dealer to 40% for a large broker-dealer. The broker-dealer has 60 days in which to establish the procedure from the time of discovery or the date of notifi cation by FINRA that the broker-dealer is subject to the rule.

The broker-dealer must record all sales force conversations. If cell phone conversations cannot be recorded, then only occasional use of cell phones by the sales force is permitted. The broker dealer must establish written supervisory procedures which:


107 Series 6

• Document the principal responsible for the review • Specify the minimum percentage of calls that will be reviewed• Explain how any random review will be performed • Address how this review will be conducted• Consider any customer complaint and disciplinary history of registered representatives• Maintain documentation of the reviews• Monitor the procedure to ensure that it is done

A broker-dealer whose personnel mix triggers this rule may not hire additional registered representatives to reduce its percentage and avoid the rule. However, if the broker-dealer terminates suffi cient personnel within 60 days, then the rule will not apply. Registered representatives with no disciplinary history who were formerly associated with a disciplined broker-dealer for 90 days or less within the past 3 years do not count toward the percentage thresholds.

A broker-dealer who triggers the telephone recording rule must begin recording within 60 days and must fi le quarterly reports with FINRA. The broker-dealer must continue the recording program for at least 3 years and must comply with all federal and state law regarding recording of telephone conversations.

3.17 Payments Involving Publications that Infl uence the Market Price of a SecurityA broker-dealer may not give anything of value to infl uence or reward any person for publishing or otherwise circulating information to infl uence the price of a security in any electronic media, such as the internet or radio. However, broker-dealers may pay to circulate advertising, research reports, and communications that disclose compensation was paid and specify the amount.

3.18 Requirements for the Use of Investment Analysis ToolsAn “investment analysis tool” is any interactive technology that creates simulations allowing an investor to see the potential outcomes of various investments, investment styles, and strategies. It also analyzes potential risks and rewards. Investment analysis tools are classifi ed as retail communication and are regulated as such by FINRA.

Any investment analysis tool which is used by a broker-dealer must be fi led with FINRA (including templates for any reports which it produces) within 10 business days of fi rst use. Any retail communication that addresses the investment tool must also be submitted within 10 business days of fi rst use.

All investment analysis tools, reports generated by the tool, and retail communication discussing the tool, must contain the following disclosures written in narrative form and prominently displayed:

• Description of the criteria and methodology including limitations and underlying assumptions• Statement noting that results can vary with each use and over time• Description of the universe of investments the tool analyzes and how the tool selects an investment (if

applicable). If the tool favors certain types of investments, an explanation for this and a statement that other investments may be similar or superior.

• The following disclosure must be displayed: “IMPORTANT: The projections or other information generated by (name of investment analysis tool) regarding the likelihood of various investment outcomes are hypothetical in nature, do not refl ect actual investment results and are not guarantees of future results.”


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3.19 Requirements for the Use of Bond Mutual Fund Volatility RatingsA mutual fund that invests in bonds typically has a volatility rating issued by an independent third party. This rating indicates how the fund’s price reacts to economic and market conditions. The rating considers the credit quality of the fund’s individual bonds, interest rate risk, currency risk, prepayment risk, and an objective analysis of the fund’s performance.

All bond mutual fund volatility ratings must meet the following criteria:

• The rating must not be called a “risk rating”• Only the most current rating may be used, and the information must be current to at least the end of the

most recent calendar quarter• The rating and disclosure statement must be “clear, concise and understandable” and include only

factors that are “objective and quantifi able”• The rating issuer must provide detailed methodology disclosure and make it available to investors

through a website and/or toll-free number

When a broker-dealer uses a bond mutual fund’s volatility rating in retail communications, the communication must be accompanied with or preceded by a prospectus. The communication must disclose all of the most recent bond mutual fund volatility ratings have been issued on the fund, the names of the ratings’ issuers, the most current rating and the date of this rating. If the most current rating has changed, then reasons for the change must be disclosed. Also, there must be a description of the rating written in narrative form that includes the following disclosures:

• A statement that no standard method exists for assigning ratings• Description of the criteria and methodologies used to develop the rating• The type of risk that the rating measures (such as short- or long-term volatility, duration, etc.)• A statement that not all bond funds have volatility ratings and that the portfolio may have changed since

the rating was issued• A statement that there is no guarantee the fund will always have the same rating or match past

performance• Any compensation that was paid for the rating

3.20 Use of Investment Companies Rankings in Retail CommunicationsA ranking entity is an independent investment information provider that rates investment company performance, for example Barron’s or Kiplinger. A ranking entity is independent from the investment company, nor is it paid by the company to publish a ranking.

If the investment company ranking was issued by the broker-dealer itself, the broker-dealer must fi le this ranking communication with FINRA at least 10 days before fi rst use. If the ranking was issued by an independent rating service, the broker-dealer must fi le this ranking communication with FINRA no later than ten days after fi rst use.

In using investment company rankings in retail communication, broker-dealers must contain the following disclosures:

• Name of the ranking entity;• Company’s investment category (such as growth or income);• Number of investment companies in the category;• Whether the investment company itself created the category;• Time period being ranked, including the fi rst and last day of the period;• Ranking criteria (yield, total return, etc.);• Whether the ranking considers sales loads;


109 Series 6

• Publisher of the ranking (newspaper or other publication);• Explanation of any symbols used in the ranking system (such as stars or bullets);• Statement that total returns or yields do not consider fees and expenses, if applicable and material;• Statement that past performance is no guarantee of future results

In addition, retail communication may not claim that an investment company is a top performing fund in its category unless the statement is true.

Investment company rankings must be at least as current as the end of the most recent calendar quarter. Rankings cannot show a time period less than one year (unless they are based on yield). Rankings must show the 1-year, 5-year, and 10-year returns unless the investment company has been in business for less than 10 years. If so, returns for each year must be shown. These standards do not apply to money market funds.


110Series 6

CHAPTER THREE — LIGHTNING FACTS

1. Only a Registered Securities Principal can approve retail communication, correspondence, and institutional communication.

2. Correspondence is electronic or written communication directed to up to 25 individuals (prospects or customers) in any 30 calendar day period. Retail communication is electronic or written communication directed to more than 25 customers or prospective customers in any 30 calendar day period. Both must be kept on fi le for 3 years from the date of fi rst use.

3. A broker-dealer and registered representative can only advertise the investment products they actually sell.

4. Generic retail communication does not refer to a specifi c security.5. Generic retail communication will name only the principal underwriter, whereas a Tombstone

advertisement will name the principal underwriter and the specifi c investment company.6. Outgoing email involving securities business correspondence must be saved and on fi le for 3 years.7. FINRA may require a member fi rm to pre-fi le all retail communication when used by a new broker-

dealer.8. All statements or illustrations of past performance must include the disclaimer that past performance

does not guarantee future results.9. The SEC required disclaimer that this security has not been approved or disapproved by the SEC is

required to be on every prospectus; it is not required on retail communication.10. Unsuitable recommendations are prohibited. Suitable investment recommendations to clients are

required.11. When including testimonials in retail communication, you must include whether or not the person was

compensated for it and the person’s qualifi cations must be revealed.12. Offers of free service which are not absolutely without cost, condition or obligation are prohibited.13. The name of FINRA can never appear larger or more prominently than the name of the member.14. A representative is not allowed to highlight, mark up, fold pages, or attach adhesive notes or paperclips

to a prospectus which he is delivering to a prospective buyer.15. The Telephone Consumer Protection Act covers both telephone and fax communications but not

email or internet communications.16. The TCPA regulates use of the telephone for the purpose of encouraging the investment or purchase

of property, goods or services (which means businesses are subject to it but not-for-profi ts such as churches and universities are not).

17. When a broker-dealer sells securities to a customer referred by a fi nancial institution, the registered representative must make special oral and written disclosures to the customer and make every effort to receive a signed customer acknowledgement of these disclosures.

18. When a broker-dealer operates on the premises of a fi nancial institution, the BD’s space must be clearly separate and prominently identifi ed.

19. Broker-dealers must annually provide each customer with FINRA’s website address, BrokerCheck Hotline number, and a statement that the investor brochure describing BrokerCheck is available.

20. Broker-dealers whose sales force contains a threshold percentage or more of registered representatives from disciplined BDs must implement a telephone recording program.

21. Broker-dealers may not compensate any entity to infl uence the price of a security through any electronic media.

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22. When a broker-dealer uses an investment analysis tool, this tool must be fi led with FINRA no later than 10 days after fi rst use and special disclosures must be made to each customer for whom the tool is used.

23. Bond mutual fund volatility ratings must meet certain criteria. When referenced in retail communication these volatility ratings must be accompanied by a prospectus and the communication must make certain disclosures.

24. Broker-dealers may only use investment company rankings that are issued by bona fi de ranking entities and these rankings must be accompanied by certain disclosures.


CHAPTER 3 RETENTION QUESTIONS

112Series 6

1. What is the primary difference between institutional and retail communications?A. Institutional communication happens completely within a regulated entity, such as email between

the marketing department and the external wholesalers who sell to institutional investors or who encourage broker-dealers to promote the fund’s shares.

B. Institutional communication is that which takes place between the broker-dealer and institutional investors, whether electronic or printed. Retail communication takes place between the broker-dealer and more than 25 individual investors, and includes advertising, sales literature, and correspondence.

C. Retail communication takes place between mutual funds and broker-dealers and their agents.D. There is no difference between institutional and retail communications. They are both forms of

advertising, sales literature, and correspondence.2. When a prospectus has been released by the SEC for distribution to the public, a registered

representative may make which of the following statements concerning that approval?A. The Securities and Exchange Commission believes the security is valuable and should be purchased

by investors.B. The SEC only approves securities that are expected to increase in value, but cannot guarantee that

such increases will happen.C. The SEC has investigated all of the claims contained in the prospectus and found them to be true.D. SEC approval merely indicates that the prospectus has been fi led with the Commission and has met

the minimum conditions necessary to be distributed to the public.3. Which of the following are requirements of the Telephone Consumer Protection Act of 1991?

I. Calls may be placed between 8 am and 9 pm at the origination point of the callII. Calls may be placed between 8 am and 9 pm at the reception point of the callIII. The fi rm must use the National Do-Not-Call list and its own internal do-not-call listIV. The fi rm may choose to use either the National Do-Not-Call list or its own internal do-not-call

listA. I and IIIB. II and IVC. II and IIID. I and IV

4. Which of these would be considered generic retail communication?A. An advertisement for a specifi c mutual fund placed in a daily metropolitan newspaper that can also

be placed in regional and national monthly magazinesB. An advertisement for a mutual fund family which includes a new account form an investor could

use to purchase shares in any fund of the family, provided the fund sends a prospectus to the new customer within 30 days

C. An advertisement printed in any publication that may refer to a family of mutual funds without referring to any specifi c fund in that family of funds

D. A preprinted form letter describing the most recent 1-, 3-, and 5-year returns for a mutual fund, personalized with the name and address of a person who doesn’t have an account with the fi rm

5. Retail Communication must not be misleading. Material misrepresentation involves which of the following?A. Any false statement of fact which is made in the prospectusB. Any three relatively unimportant pieces of information have been omitted from the prospectusC. Charts, graphs, or other depictions of past performance accompanied by a disclaimer that future

results cannot be guaranteedD. Statements about the benefi ts of a particular investment accompanied by an equally prominent

discussion of the risks and limitations associated with the investment itself


113 Series 6

6. A money market mutual fund may make which of the following statements?I. This fund is not guaranteed by the FDIC and may lose valueII. This fund intends to maintain a daily value somewhere between $0.90 and $1.10 per share

most of the time, but cannot guarantee this will be always be trueIII. This fund seeks to maintain a value of $1.00 per shareIV. The fund will not lose value as long as the investor holds all shares at least fi ve yearsA. I and II B. I and III C. II and IV D. III and IV

7. When does front running occur?A. When a fi rm or its representative “tests the water” for a customer by making a trade for the fi rm’s

account to see if the price of the security is stable, and then sells that security to the customer for the same price

B. When a fi rm or its representative executes trades based on privileged information before executing customers’ trades in that security

C. When a customer places an order based on material nonpublic information more than 24 hours in advance of the information being released to the public

D. When a customer places an order based on material nonpublic information less than 24 hours in advance of the information being released to the public

8. Registered fi rms are required to supervise their representatives. How is supervision achieved? I. The fi rm adopts written supervisory proceduresII. The fi rm implements written supervisory proceduresIII. The fi rm monitors compliance with written supervisory proceduresIV. The fi rm takes action when it becomes aware that written supervisory procedures are being

violatedA. I and IVB. I and IIC. II and IIID. I, II, III and IV

9. When may a registered representative be compensated for outside employment or business activities?A. Only when the compensation is derived from a concurrently employing FINRA-member fi rm listed

on Form U-4B. Only after the employing fi rm has given written approval for such outside activitiesC. Only after the representative has given written notice to the fi rm of involvement in the outside

activityD. Only when the activity involves selling away

10. Which of the following is true with respect to a statement of additional information?A. It must be distributed with a prospectus.B. It must be forwarded to individuals upon request.C. It forms part of the annual report.D. “Statement of additional information” is the technical name for “proxy statement."


114Series 6

11. When a registered representative has been authorized to engage in compensation-producing activities involving securities transactions away from the fi rm, which of these responsibilities does the fi rm have?A. It must monitor the transactions of the representative and record them in the books and records of

the fi rm.B. It must request duplicate trade confi rmations from the other fi rm.C. It may require the representative to pay the fi rm 10% of the total compensation received in exchange

for obtaining approval to engage in the transactions.D. Although it must monitor the representative’s transactions, the fi rm has no other responsibilities.

Direct responsibility for a representative’s transactions rests solely with the fi rm that compensates the representative for the transaction.

12. Under the Safe Harbor Provisions, a member or associated person making telephone solicitations will not be liable if the member’s routine business practice meets all the following standards, except:A. The member has established and implemented written procedures to comply with the national do-

not-call rules.B. The member has trained its personnel, and any entity assisting in its compliance, in procedures

established pursuant to the national do-not-call rules. C. The member has maintained and recorded a list of telephone numbers that it cannot contact D. The member uses a process to prevent telephone solicitations to any telephone member on any list

established and obtained from the administrator of the registry no more than 60 days prior to the date any call is made.

13. A registered representative wants to send a research report to a client regarding a specifi c mutual fund. Which of the following is true regarding the research report?A. It is classifi ed as retail communication and must be preceded or accompanied by a current

prospectus.B. Research reports on mutual funds are prohibited by the SEC because they are essentially the same as

an initial public offering.C. It may only be sent to current and former investors of that mutual fund.D. Only a registered principal may use any sales literature besides the prospectus.

14. Under FINRA Conduct Rules, the general standards applicable to retail communications applies to which of the following situations?I. The member sponsors an investment seminar for the publicII. An offi cer of a member participates in a television program on investmentsIII. A registered representative of a member sends a form letter in July to all 150 of his/her

existing clients and to 30 additional prospective customersIV. A registered representative serves as a guest speaker on investments at a local club meetingA. I & II B. I & IIIC. II & IV D. I, II, III & IV

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