Stock Trading Professional Standards & Competencies 5 — Questions and Answers
Question 1: A trader at a hedge fund is under pressure from management to inflate the fund's performance figures in monthly reports to investors. The ethical course of action is to:
- Comply with management's request since they are responsible for fund performance
- Refuse to falsify records and report the request to the firm's compliance department (Correct answer)
- Adjust figures modestly to meet management's expectations without significant distortion
- Delay the reports until actual performance improves
Correct answer: Refuse to falsify records and report the request to the firm's compliance department
Falsifying performance reports constitutes securities fraud; the trader must refuse and escalate to compliance, as following illegal orders is not a defense.
Question 2: The 'fiduciary standard' differs from the 'suitability standard' in that fiduciaries must:
- Recommend only government-backed securities
- Always act in the client's best interest, not just make suitable recommendations (Correct answer)
- Disclose fees only upon client request
- Complete transactions within one business day
Correct answer: Always act in the client's best interest, not just make suitable recommendations
The fiduciary standard is a higher legal duty requiring advisers to always act in the client's best interest, while the suitability standard only requires recommendations to be appropriate for the client.
Question 3: What is the primary function of FINRA's arbitration process in securities disputes?
- To prosecute criminal violations of securities laws
- To provide a forum for resolving disputes between investors and broker-dealers outside of court (Correct answer)
- To regulate the conduct of registered investment advisers
- To set margin requirements for securities accounts
Correct answer: To provide a forum for resolving disputes between investors and broker-dealers outside of court
FINRA arbitration provides a faster, less expensive alternative to litigation for resolving disputes between investors and broker-dealers or between industry professionals.
Question 4: Which of the following describes 'wash trading'?
- Cleaning up a portfolio by selling all losing positions before year-end
- Simultaneously buying and selling the same security to create the appearance of trading activity (Correct answer)
- Laundering funds through securities transactions
- Executing trades using offshore accounts to avoid taxes
Correct answer: Simultaneously buying and selling the same security to create the appearance of trading activity
Wash trading involves a trader buying and selling the same security to generate artificial trading volume, creating a misleading appearance of market activity without actual change in ownership.
Question 5: Under SEC Regulation S-P, broker-dealers are required to:
- Report all short positions to the SEC daily
- Protect the privacy of customer financial information and provide privacy notices (Correct answer)
- Register all algorithmic trading strategies with the SEC
- Disclose all proprietary trading activities to customers
Correct answer: Protect the privacy of customer financial information and provide privacy notices
SEC Regulation S-P requires financial institutions to safeguard customer financial information and provide customers with notices about their privacy policies and practices.
Question 6: A registered representative recommends a high-commission variable annuity to an 80-year-old client with a conservative risk profile and a 3-year investment horizon. This most likely violates:
- Anti-money laundering rules
- Suitability and Regulation Best Interest standards (Correct answer)
- Short-selling restrictions
- Prospectus delivery requirements
Correct answer: Suitability and Regulation Best Interest standards
Recommending a complex, illiquid product with high fees to an elderly conservative investor with a short time horizon violates suitability standards and Reg BI's best interest obligation.
Question 7: What is the purpose of a 'cooling-off period' in the context of new securities issuances?
- To allow underwriters to stabilize market prices after an IPO
- To provide investors time to review the prospectus before committing to a purchase (Correct answer)
- To give regulators time to investigate potential insider trading before trading begins
- To prevent short-selling during the first 30 days of a new issue
Correct answer: To provide investors time to review the prospectus before committing to a purchase
The cooling-off period between registration and the effective date allows investors to review the prospectus and make informed decisions before committing to purchase new securities.
Stock Trading Professional Standards & Competencies 5
A trader at a hedge fund is under pressure from management to inflate the fund's performance figures in monthly reports to investors.
The ethical course of action is to: