QFC Regulatory Compliance & Ethics 3 — Questions and Answers
Question 1: Under the Global Investment Performance Standards (GIPS), composite performance must include:
- Only the top-performing accounts in the strategy
- All actual, fee-paying, discretionary portfolios managed in that strategy (Correct answer)
- Representative sample portfolios chosen by the firm
- Only accounts with at least 3 years of history
Correct answer: All actual, fee-paying, discretionary portfolios managed in that strategy
GIPS requires composites to include all actual, fee-paying, discretionary portfolios managed according to the same investment mandate.
Question 2: Which regulation requires U.S. registered investment advisers to implement written compliance policies and procedures?
- Sarbanes-Oxley Act Section 302
- Investment Advisers Act Rule 206(4)-7 (Correct answer)
- Securities Act Section 11
- Exchange Act Rule 15c3-1
Correct answer: Investment Advisers Act Rule 206(4)-7
Rule 206(4)-7 under the Investment Advisers Act requires registered investment advisers to adopt and implement written compliance policies and procedures.
Question 3: An algorithmic trading firm's strategy causes a mini flash crash by amplifying market volatility. Under FINRA rules, this may constitute:
- Legitimate high-frequency trading
- Disruptive quoting or layering that manipulates market prices (Correct answer)
- Normal market making activity
- Acceptable arbitrage behavior
Correct answer: Disruptive quoting or layering that manipulates market prices
FINRA Rule 5210 prohibits disruptive quoting practices including layering and spoofing that manipulate price discovery.
Question 4: The concept of 'best execution' in the context of quantitative trading requires brokers to:
- Always achieve the lowest commission
- Execute orders on terms most favorable to the client considering multiple factors (Correct answer)
- Use only lit exchanges for price discovery
- Guarantee the NBBO at time of order entry
Correct answer: Execute orders on terms most favorable to the client considering multiple factors
Best execution requires considering multiple factors including price, speed, likelihood of execution, and market impact, not just commission.
Question 5: Which of the following is an example of 'marking the close' market manipulation?
- Executing large trades in the first minute of trading
- Placing orders near market close to artificially influence the settlement price (Correct answer)
- Using closing price data for portfolio valuation
- Submitting orders that execute at the closing auction
Correct answer: Placing orders near market close to artificially influence the settlement price
Marking the close involves trading near market close with the intent to artificially influence settlement prices, which is prohibited.
Question 6: Under SEC Regulation SHO, a broker-dealer must locate shares before executing a short sale to prevent:
- Excessive volatility
- Naked short selling and failure-to-deliver situations (Correct answer)
- Front-running of institutional orders
- Wash trading violations
Correct answer: Naked short selling and failure-to-deliver situations
Reg SHO's locate requirement prevents naked short selling by ensuring shares can be borrowed before the short sale is executed.
Question 7: A quantitative hedge fund's risk model uses historical data that significantly underestimates tail risk. The fund's compliance obligation includes:
- Disclosing model limitations to investors in fund documents (Correct answer)
- Keeping model weaknesses confidential to protect intellectual property
- Only disclosing if losses exceed 10% in a month
- Reporting to FINRA within 24 hours
Correct answer: Disclosing model limitations to investors in fund documents
Material model limitations and risks must be disclosed to investors in offering documents and periodic reporting to fulfill fiduciary and regulatory obligations.
QFC Regulatory Compliance & Ethics 3
Under the Global Investment Performance Standards (GIPS), composite performance must include: