Violations You Need to Understand for the Series 7 Exam - dummies

Violations You Need to Understand for the Series 7 Exam

By Steven M. Rice

You need to be aware of some violations not only for the Series 7 exam but also so you stay out of trouble. Some of the violations are more connected with broker-dealers, some with registered reps, and some with investment advisers:

  • Commingling of funds: Combining a customer’s fully paid and margined securities or combining a firm’s securities with customer securities.

  • Interpositioning: Having two securities dealers act as agents for the same exact trade so that two commissions are earned on one trade.

  • Giving (or receiving) gifts: Giving or receiving a gift of more than $100 per customer per year. Business expenses (lunch, dinner, hotel rooms, and so on) are exempt from this MSRB rule.

  • Making political contributions (paying to play): Under the Investment Advisers Act of 1940, investment advisers are prohibited from providing investment advisory services for a fee to a government client for two years after a contribution is made. This rule applies not only to the adviser, executives, and employees making contributions to certain elected officials but also to candidates who may later be elected. In addition, investment advisers are prohibited from soliciting contributions for elected officials or candidates if the investment adviser is seeking or providing government business.

  • Freeriding: Allowing a customer to buy or sell securities without paying for the purchase.

  • Backing away: Failure on the part of a securities dealer to honor a firm quote.

  • Churning: A violation whereby a registered rep excessively trades a customer’s account for the sole purpose of generating commission.

  • Matching orders: Illegally manipulating the price of a security to make the trading volume appear larger than it really is, such as two brokerage firms working in concert by trading the same security back and forth.

  • Painting the tape: Creating the illusion of trading activity due to misleading reports on the consolidated tape — for example, reporting a trade of 10,000 shares of stock as two separate trades for 5,000 shares each.

  • Frontrunning: A violation in which a registered rep executes a trade for himself, his firm, or a discretionary account based on knowledge of a block trade (10,000 shares or more) before the trade is reported on the ticker tape.

  • Capping: A form of market manipulation designed to keep the price of a security from increasing.

  • Pegging: A form of market manipulation designed to keep the price of a security stable (neither increasing nor decreasing).

  • Prearranging trades: A prearranged trade is an illegal agreement between a registered rep and a customer to buy back a security at a fixed price.

  • Marking the close/marking the open: Executing a series of trades within minutes of the open or close of the market to manipulate the price of a security.

  • Paying the media: A violation in which brokerage firms or affiliated persons pay an employee of the media to affect the price of a security; for example, paying a TV stock expert to recommend a security that the firm has in its inventory.

  • Spreading market rumors: Members are prohibited from spreading false market rumors that may prompt others to either buy or sell a security.

  • Paying for referrals: Members or persons associated with a member (for example, registered reps) are prohibited from paying cash or noncash compensation to any person except those registered with the member firm or other FINRA members. A violation occurs in the event that compensation is paid to a nonmember for locating, introducing, or referring a client.