FINRA Practice and Application 3 — Questions and Answers
Question 1: A broker-dealer firm allows a rep to act as a trustee for a customer's estate. Under FINRA rules, this arrangement requires:
- Prior written approval from the firm (Correct answer)
- Notification to FINRA within 10 business days
- SEC registration as an investment adviser
- No special action if the estate is under $500,000
Correct answer: Prior written approval from the firm
Acting as a trustee for a customer is an outside business activity that requires prior written firm approval under FINRA rules.
Question 2: A day trader executes four or more round-trip trades in five business days in a margin account and the trades exceed 6% of total trading activity. The firm must classify this account as a:
- Pattern day trader account requiring $25,000 minimum equity (Correct answer)
- Restricted margin account under Regulation T
- Cash account subject to the 2-day settlement rule
- Portfolio margin account eligible for reduced requirements
Correct answer: Pattern day trader account requiring $25,000 minimum equity
FINRA Rule 4210 defines a pattern day trader as one who executes four or more day trades in five business days if those trades exceed 6% of trading activity, requiring a $25,000 minimum.
Question 3: Which of the following actions by a registered representative would be considered 'churning'?
- Executing excessive trades in a discretionary account to generate commissions (Correct answer)
- Recommending a high-turnover mutual fund with a low expense ratio
- Placing multiple small orders to achieve best execution
- Switching a client between two no-load funds for rebalancing
Correct answer: Executing excessive trades in a discretionary account to generate commissions
Churning involves excessive trading in a customer's account to generate commissions without regard for the customer's investment goals.
Question 4: A customer places a GTC (Good Till Cancelled) limit buy order at $40. The stock pays a $2 cash dividend and the ex-dividend date passes. Under NYSE rules, the limit price is automatically adjusted to:
- $38 (Correct answer)
- $40
- $42
- $41
Correct answer: $38
Open limit orders on the NYSE are reduced by the dividend amount on the ex-dividend date unless the customer specifies 'Do Not Reduce.'
Question 5: Which of the following is a characteristic of Regulation T as it applies to initial margin requirements for purchasing securities?
- Customers must deposit 50% of the purchase price for most equity securities (Correct answer)
- Customers must deposit 25% of the purchase price for NYSE-listed stocks
- The Federal Reserve sets a 30% initial margin requirement for all securities
- Initial margin applies only to securities held more than 30 days
Correct answer: Customers must deposit 50% of the purchase price for most equity securities
Regulation T, set by the Federal Reserve, requires customers to deposit 50% of the purchase price as initial margin for most equity securities.
Question 6: An investor sells short 100 shares of XYZ at $60. The stock rises to $75. What is the investor's unrealized loss?
- $1,500 (Correct answer)
- $1,500 gain
- $750
- $6,000
Correct answer: $1,500
The investor sold at $60 and the stock is now $75; the loss is ($75 - $60) × 100 = $1,500.
Question 7: A registered rep who is also a licensed insurance agent sells a customer a life insurance policy through an unaffiliated insurer. Under FINRA rules, this activity:
- Must be disclosed and approved by the member firm as an outside business activity (Correct answer)
- Is automatically permitted because insurance is not a security
- Requires SEC registration as an investment adviser
- Must be reported to FINRA but not to the member firm
Correct answer: Must be disclosed and approved by the member firm as an outside business activity
Selling insurance products outside the firm is an outside business activity requiring firm disclosure and approval regardless of whether it involves securities.
FINRA Practice and Application 3
A broker-dealer firm allows a rep to act as a trustee for a customer's estate.
Under FINRA rules, this arrangement requires: