FINRA Industry Regulations 3 — Questions and Answers
Question 1: Which act established the Securities Investor Protection Corporation (SIPC)?
- Securities Exchange Act of 1934
- Investment Company Act of 1940
- Securities Investor Protection Act of 1970 (Correct answer)
- Dodd-Frank Act of 2010
Correct answer: Securities Investor Protection Act of 1970
The Securities Investor Protection Act of 1970 created SIPC to protect customers of failed broker-dealers up to specified limits.
Question 2: A registered representative convinces elderly customers to frequently switch mutual funds to generate commissions. This activity most likely violates FINRA rules related to:
- Front-running
- Churning (Correct answer)
- Painting the tape
- Interpositioning
Correct answer: Churning
Churning involves excessive trading in a customer's account primarily to generate commissions, violating the broker's duty of loyalty.
Question 3: Under FINRA Rule 5130, which of the following persons is generally PROHIBITED from purchasing shares in a new issue (IPO) at the public offering price?
- A retail customer with no affiliation to the broker-dealer
- A foreign national investing through a US brokerage
- A finder who assisted in the IPO for a cash fee (Correct answer)
- An institutional investor purchasing for a pension fund
Correct answer: A finder who assisted in the IPO for a cash fee
Rule 5130 prohibits 'restricted persons,' including finders who received compensation related to the offering, from purchasing new issue shares at the public offering price.
Question 4: The 'know your customer' (KYC) obligation under FINRA Rule 2090 requires firms to:
- Collect Social Security numbers from all customers
- Use due diligence to know the essential facts about every customer and account (Correct answer)
- Verify customer identity through in-person meetings only
- Obtain three forms of government-issued ID before opening accounts
Correct answer: Use due diligence to know the essential facts about every customer and account
Rule 2090 requires broker-dealers to use reasonable diligence to know the essential facts concerning every customer and maintain an understanding of the customer's account.
Question 5: A broker-dealer receives a customer order to buy 1,000 shares and then executes a proprietary buy order in the same security before filling the customer order. This is known as:
- Interpositioning
- Front-running (Correct answer)
- Painting the tape
- Backing away
Correct answer: Front-running
Front-running occurs when a broker trades for the firm's own account ahead of a known customer order to profit from the anticipated price movement.
Question 6: Under SEC Regulation SP (Privacy of Consumer Financial Information), broker-dealers must provide customers with a privacy notice:
- Only upon customer request
- Annually and at the time of establishing a customer relationship (Correct answer)
- Every three years
- Only when sharing information with unaffiliated third parties
Correct answer: Annually and at the time of establishing a customer relationship
Regulation SP requires broker-dealers to provide initial and annual privacy notices to customers describing their information-sharing practices.
Question 7: Which of the following best describes the 'pattern day trader' rule under FINRA Rule 4210?
- Any customer who places 3 or more day trades in a week is a pattern day trader
- A customer who executes 4 or more day trades within 5 business days, where those trades are more than 6% of total trading activity, must maintain $25,000 in equity (Correct answer)
- Day traders must maintain $10,000 minimum equity at all times
- Pattern day traders are prohibited from trading options
Correct answer: A customer who executes 4 or more day trades within 5 business days, where those trades are more than 6% of total trading activity, must maintain $25,000 in equity
FINRA Rule 4210 defines a pattern day trader as one who executes 4 or more day trades within 5 business days if those trades exceed 6% of their total trades, requiring a $25,000 minimum equity.
FINRA Industry Regulations 3
Which act established the Securities Investor Protection Corporation (SIPC)?