Stock Trading Professional Standards & Competencies 3 — Questions and Answers
Question 1: What is 'churning' in the context of professional trading standards?
- Rapidly entering and exiting positions to capitalize on volatility
- Excessively trading a client's account to generate commissions (Correct answer)
- Using algorithmic strategies to increase trading volume
- Rebalancing a portfolio more than once per quarter
Correct answer: Excessively trading a client's account to generate commissions
Churning is the unethical and illegal practice of excessively trading a client's account primarily to generate commissions for the broker rather than to benefit the client.
Question 2: Under SEC Regulation Best Interest (Reg BI), broker-dealers must act in whose best interest when making recommendations?
- The broker-dealer firm's interest
- The retail customer's best interest (Correct answer)
- The market maker's interest
- FINRA's mandated interest
Correct answer: The retail customer's best interest
SEC Regulation Best Interest requires broker-dealers to act in the best interest of the retail customer at the time a recommendation is made.
Question 3: A trader places large buy orders to artificially raise a stock's price, then sells their holdings at the inflated price. This scheme is known as:
- Wash trading
- Pump and dump (Correct answer)
- Naked short selling
- Front-running
Correct answer: Pump and dump
A pump-and-dump scheme involves artificially inflating a stock's price through false or misleading information, then selling shares at the peak before the price collapses.
Question 4: Which of the following best describes the 'know your customer' (KYC) obligation?
- Verifying only the customer's identity for anti-money laundering purposes
- Understanding a customer's financial situation, investment objectives, and risk tolerance before recommending investments (Correct answer)
- Monitoring customer accounts for suspicious trading activity only
- Confirming customers have passed relevant securities licensing exams
Correct answer: Understanding a customer's financial situation, investment objectives, and risk tolerance before recommending investments
KYC requires broker-dealers to gather sufficient information about customers to make suitable investment recommendations tailored to their individual circumstances.
Question 5: What is the primary purpose of a firm's written supervisory procedures (WSP)?
- To document client complaints
- To establish guidelines ensuring compliance with securities laws and firm policies (Correct answer)
- To track employee performance reviews
- To outline marketing and sales strategies
Correct answer: To establish guidelines ensuring compliance with securities laws and firm policies
Written supervisory procedures establish the compliance framework and controls a firm uses to ensure adherence to securities laws, regulations, and internal policies.
Question 6: A research analyst owns shares in a company they are about to rate as a 'Strong Buy.' What is the appropriate professional course of action?
- Sell the shares before publishing the report
- Disclose the ownership interest in the research report (Correct answer)
- Assign the coverage to another analyst
- Rate the stock as 'Neutral' to avoid conflict
Correct answer: Disclose the ownership interest in the research report
Disclosure of the analyst's personal ownership interest allows investors to assess potential conflicts of interest and evaluate the recommendation accordingly.
Question 7: Under FINRA rules, what is required before a registered person can engage in outside business activities?
- Written approval from FINRA directly
- Notification to and approval from their member firm (Correct answer)
- Approval from the SEC only
- No approval is required if the activity is unrelated to securities
Correct answer: Notification to and approval from their member firm
FINRA Rule 3270 requires registered persons to provide prior written notice to their member firm before engaging in any outside business activity, and firms must approve or deny such activities.
Stock Trading Professional Standards & Competencies 3
What is 'churning' in the context of professional trading standards?