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Sample Chapter:
Section One
Brokerage Office Procedures
Introduction
Guidelines for the practices that a brokerage firm uses to conduct the operation of its
daily business are regulated by industry, state, and federal regulators. These guidelines
are the foundation for the way that the firm handles all business, from hiring a new agent
to executing a customer’s order. All candidates must have a full understanding of a
brokerage firm’s operations and procedures to successfully complete the exam
Hiring New Employees
A registered principal of a firm will be the individual who interviews and screens
potential new employees. They will be required to make a thorough investigation into the
candidate’s professional and personal backgrounds. With few exceptions other than
clerical personnel, all new employees will be required to become registered as an
associated person with the firm. The new employee will begin their registration process
by filling out and submitting a Uniform Application for Securities Industry Registration,
also known as Form U4. The Form U4 is used to collect the applicant’s personal and
professional history including:
ü 10-year employment history
ü Five-year resident history
ü Legal name and any aliases used
ü Any legal or regulatory actions
The principal of the firm is required to verify the employment information for the last
three years and must attest to the character of the applicant by signing Form U4 prior to
its submission to the NASD. All U4 forms will be sent to the Central Registration
Depository (CRD) for processing and recording. Any applicant who has answered yes to
any of the questions on the form regarding their background must give a detailed
explanation in the DRP pages attached to the form. The applicant is not required to
provide information regarding:
ü Marital status
ü Educational background
ü Income or net worth
The only information regarding the employee’s finances that is disclosed on the U4 form
is if the associated person has ever declared bankruptcy. Any development that would
cause an answer on the associated person’s U4 to change requires that the member update
the U4 within 30 days of when the member becomes informed of the event. In the case of
an event that could cause the individual to become statutorily disqualified, such as a
felony conviction or a misdemeanor involving cash or securities, the member must
update the associated person’s U4 within 10 business days of learning of the event.
Resignation of a Registered Representative
If a registered representative voluntarily resigns or has their association with a member
firm terminated for any reason, the member must fill out and submit a Uniform
Termination Notice for Securities Industry Registration, known as Form U5. The member
must submit the U5 to the NASD within 30 days of the termination. The member firm is
also required to give a copy of the U5 to the representative upon termination. The
member must also state the reason for the termination, either voluntary or for cause. An
associated person’s registration is non-transferable. A representative may not simply
move their registration from one firm to another. The employing firm that the
representative is leaving must fill out and submit a U5 to the NASD, which terminates the
representative’s registration. The new employing firm must fill out and submit a new U4
to begin a new registration for the associated person with the new employer. The new
employer is required to obtain a copy of the U5 form filed by the old employing member
either from the employee or directly from the NASD. The previous employer is not
required to provide a copy to the new member firm. If the new employing member asks
the associated person for a copy of the U5, they have two business days to provide it. A
representative who leaves the industry for more than 24 months is required to re-qualify
by exam. During a period of absence from the industry of two years or less the NASD
retains jurisdiction over the representative in cases involving customer complaints and
violations.
Registration Exemptions
The following individuals are exempt from registration:
ü Clerical
ü Non-supervising officers and managers not dealing with customers
ü Non-U.S. citizens working abroad
ü Floor personnel
Persons Ineligible to Register
Individuals applying for registration must meet the association’s requirements in the
following areas:
ü Training
ü Competence
ü Experience
ü Character
Anyone who fails to meet the association’s requirements in any of the above listed areas
may not become registered. An individual may also be disqualified by statute or through
rules for any of the following:
ü Expulsion, suspension, or disciplinary actions by the Securities Exchange
Commission (SEC) or any foreign or domestic self-regulatory organization (SRO)
ü The individual caused the expulsion or suspension of a broker dealer or principal
ü The individual made false or misleading statements on the application for
registration on Form U4 or Form B-D
ü Felony conviction or misdemeanor involving securities within the last 10 years
ü Court injunction or order barring the individual
Disciplinary Actions Against a Registered Representative
If another industry regulator takes disciplinary action against a representative, the
employing member firm must notify the NASD. Actions by any of the following should
be immediately disclosed to the association:
ü SEC
ü An exchange or association
ü State regulator
ü Clearing firm
ü Commodity regulatory body
All disclosures must include the type of action brought as well as the name of the party
bringing the actions and the name of the representative involved. NASD members are
required to regulate the activities of its associated people and must disclose to the
association any action that the member takes against a registered representative.
Termination for Cause
A member may terminate a registered representative for cause if the representative has:
ü Violated firm policy
ü Violated the rules of the New York Stock Exchange (NYSE), NASD, SEC, or any
other industry regulator
ü Violated state or federal securities laws
A firm may not terminate a representative who is the subject of investigation by any
securities industry regulator until the investigation is completed.
Outside Employment
If a registered representative wants to obtain employment outside of their position with a
member firm, the registered representative must first provide written notification to the
employing member firm. The member firm may reject or limit the representative’s
outside employment. Exceptions to this rule are if the registered representative is a
passive investor in a business or if the representative owns rental property. All other
outside business activities must be disclosed to the member firm. If the member is a
NYSE member, they must provide the representative with prior written approval before
the representative engages in any outside activity.
Private Securities Transactions
A registered representative may not engage in any private securities transactions without
first obtaining the broker dealer’s prior written approval. The registered representative
must provide the employing firm with all documentation regarding the investment and
the proposed transaction. An example of a private securities transaction would be if a
representative helped a start-up business raise money through a private placement. If the
representative is going to receive compensation, the employing member firm must
supervise the transaction as if the firm itself executed the transaction. If a representative
sells investment products that the employing member does not conduct business in
without the member’s knowledge, then the representative has committed a violation
known as selling away. An exception to this is if the representative is helping an
immediate family member raise money and the representative receives no compensation
for their role in the private transaction. In this case, the notification and permission of the
member is not required.
Gift Rule
Broker dealers may not pay compensation to employees of other broker dealers. If a
broker dealer wants to give a gift to an employee of another broker dealer, it must:
ü Be valued at less than $100 per person per year
ü Be given directly to the employing member firm for distribution to the employee
ü Have the employing member’s prior approval for the gift
The employing member must obtain a record of the gift, including the name of the giver,
the name of the recipient, and the nature of the gift. These rules have been established to
ensure that broker dealers do not try to influence the employees of other broker dealers.
An exception to this rule would be in cases where an employee of one broker dealer
performs services for another broker dealer under an employment contract. The following
are also excluded from the $100 limit:
ü Occasional meals
ü Occasional tickets to sporting events
ü Business-related travel
Records of gifts and employment contracts must be retained for three years. Prior NASD
approval is not required for employment contracts between members. The gift rule also
applies to gifts given to or received from customers of the firm or agent.
Note: Firms and agents also may not give a gift to influence any report or dissemination
of information designed to influence the price of a security.
Sharing in a Customer’s Account
It is permissible for a representative to maintain a joint account with a customer as long
as the firm approves it in advance. The representative may share in the profit and loss of
the account only in direct relation to their contribution to the account. A registered
representative is precluded from sharing in the profit and loss of an account without
making any financial contribution to the account.
Borrowing and Lending Money
A registered representative or an investment advisor may not borrow money or securities
from a client unless the client is a bank or other financial institution that is in the business
of lending money. They are also prohibited from lending money or securities to a client.
Broker dealers making margin loans are excluded from this rule.
Becoming a Stockholder
We need to review how someone becomes a stockholder. While some people purchase
the shares directly from the corporation when the stock is offered to the public directly,
most investors purchase the shares from other investors. These investor-to-investor
transactions take place in the secondary market on the exchange or in the over-thecounter
market. Although the transaction in many cases only takes seconds to execute,
trades actually take several days to fully complete. Lets review the important dates
regarding transactions, which are done for a “regular way” settlement.
Trade Date
The trade date is the day when the order is actually executed. Although an order has been
placed with a broker, it may not be executed on the same day. There are certain types of
orders that may take several days or even longer to execute. A market order, however,
will be executed as soon as it is presented to the market, making the trade date the same
day the order was entered.
Settlement Date
The buyer of a security actually becomes the owner of record on the settlement date.
When an investor buys a security from another investor, the selling investor’s name is
removed from the security and the buyer’s name recorded as the new owner. Settlement
date is three business days after the trade date. This is known as T + 3 for all regular way
transactions in common stock, preferred stock, corporate bonds, and municipal bonds.
Government bonds all settle the next business day following the trade date and a trade
done on a cash basis settles on the same day regardless of the security involved in the
transaction. Settlement dates are set by the Uniform Practice Code.
Payment Date
The payment date is the day when the buyer of the security has to have the money to the
brokerage firm to pay for the purchase. Payment date for securities under the industry
rules is five business days after the trade date, or T + 5. Payment dates are regulated by
the Federal Reserve Board under Regulation T of the Securities Exchange Act of 1934.
While many brokerage firms require their customers to pay for their purchases sooner
than the rules state, the customer has up to five business days to pay for the trade.
Violation
If the customer fails to pay for the purchase within the five business days allowed, the
customer is in violation of Regulation T. As a result, the brokerage firm will “sell out”
and freeze the customer’s account. On the sixth business day following the trade date,
the brokerage firm will sell out the securities that the customer failed to pay for. The
customer is responsible for any loss that may occur as a result of the “sell out” and the
brokerage firm may sell out shares of another security in the investor’s account in order
to cover the loss. The brokerage firm will then freeze the customer’s account, which
means that the customer must deposit money up front for any purchases they want to
make in the next 90 days. After the 90 days have expired, the customer is considered to
have reestablished good credit and may then conduct business in the “regular way” and
take up to five business days to pay for their trades. A customer may get an additional
five business days to pay for the trade by requesting an extension. An extension request
must be submitted to the NYSE or NASD before the expiration of the fifth business day.
A broker dealer may ignore a call for cash of $1,000 or less.
Customer Confirmations
All customers must be sent a confirmation at or before the completion of the transaction.
Industry rules consider the completion of the transaction to be the settlement date. It is
unlawful to settle a transaction without having sent a confirmation of the transaction to
the customer. All customer confirmations must include:
ü Customer’s name and account number
ü Description of the transaction, such as buy or sell
ü Trade date and settlement date
ü Number of shares, bonds, or units
ü Price
ü Amount due or owed
ü Whether the firm acted as an agent or principal
ü Whether the firm acted as agent for the other side of the transaction—known as
“dual agency”
ü Amount of commission or markup or markdown
ü If the firm makes a market in the security
ü If there is a control relationship between the firm and the issuer of the security
ü Information regarding where the transaction was executed
ü If the firm received payment for executing the order with another firm
ü The time of execution or a statement that the time will be furnished upon request
Rules for Good Delivery
All securities delivered by a customer or another broker dealer must be in good condition
and must:
ü Be signed by all owners and all owners must be alive
ü Be in the correct denominations, such as number of shares or par value of bonds
ü Have all attachments
ü Be accompanied by a uniform delivery ticket
The owner of a security must endorse the certificate at the time of sale to ensure its
negotiability or may sign a stock or bond power, also known as a power of substitution.
The stock power when attached to the certificate will make it negotiable and includes an
irrevocable power of attorney. All signatures must be accepted by the transfer agent. To
ensure that the transfer agent accepts the signatures on certificates delivered by NYSE
member firms, the NYSE started the Medallion Signature Guarantee Program, which
allows NYSE member to stamp the certificates with a medallion rather than sign them.
This stamp ensures that the transfer agent will accept the certificates for transfer, and
provides indemnification insurance for fraud. The Medallion Program members pay to
participate.
Examples of invalid signatures are:
ü The signature of a minor
ü The signature of a deceased person
ü The signature of only one owner if jointly registered
ü A forged signature
Rejection of Delivery
The buying firm may reject the delivery of securities from the selling member if:
ü The certificates are mutilated
ü The certificates are not in the proper denominations
ü All attachments are not present
ü The signatures are invalid
ü The signatures have not been guaranteed
ü The securities are delivered prior to settlement
Customer Account Statements
A customer must receive a statement every month that there is activity in the account. All
customers must receive account statements at least quarterly when there has been no
activity in the account. Examples of activity include:
ü Purchases and sales
ü Dividend and interest received
ü Addition or withdrawal of cash or securities
Customer account statements must show:
ü All positions in the account
ü All activity since the last statement
ü All credit and debit balances
Brokerage firms are required to disclose their financial condition to their clients by
sending them a balance sheet every six months or on the request of a customer with cash
or securities on deposit.
Carrying of Customer Accounts
Not all brokerage firms maintain the physical possession of the customers’ cash and
securities. A brokerage firm that maintains the account of its customers and holds their
cash and securities is known as a “carrying firm” or a self-clearing member. A broker
dealer may find it easier to have another member provide the clearing and custodial
functions for its customers’ accounts. This type of broker dealer is known as an
“introducing broker dealer.” The introducing member forwards all cash and securities to
the carrying or clearing member for deposit into the customers’ accounts. The clearing
firm sends the customers’ statements and confirmations to the introducing firm’s
customers. An introducing member may also choose to clear their trades through an
omnibus account maintained at the clearing firm. In this case, all transactions are cleared
through one account and the clearing member does not know for whom the trade was
executed. The introducing member is required to send customer confirmations if they
clear through an omnibus account. Omnibus accounts are not allowed to purchase
securities on margin for customers. All securities must be paid for in full
NASD Series 26 Text Book & Series 26 Exam Prep Software Package Investment Company Products/Variable Contracts Limited Principal
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Series 26 Exam Prep
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Copyright © 2007
The Securities Institute of America, Inc.
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NASD Securities
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Series 26:
Investment Company Products/Variable Contracts
(Pub. 2007, 200+ pages)
Copyright © 2007
The Securities Institute of America, Inc.
All Rights Reserved.
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NASD Series 26 Text Book & Series 26 Exam Prep Software Package Investment Company Products/Variable Contracts Limited Principal
