Friday, August 28, 2015

Suitability Question - DPPs

Let's look at a practice question concerning suitability and direct participation programs:

If a customer on your book of business is expressing interest in a direct participation program, which of the following would you discuss with him first?
A. his appetite for risk
B. his need for liquidity
C. his experience with lower-quality bond investments  
D. his need for tax shelter

EXPLANATION: this is how the Series 7 maintains its tough reputation--all four answer choices look pretty good at first. Your job is to find fault with three of them. Are all DPP investments risky? Well--they all lack liquidity, which is a type of risk. But, existing properties is not as risky as raw land once you get past the liquidity problem. I'm not sure why this investor needs experience in junk bonds, which would not be illiquid or nearly as high-risk as most DPPs. Tax shelter is important . . . for most DPPs. But raw land programs provide no tax shelter.
Okay, so what would apply to all DPP investments?
A lack of liquidity. So, what should you discuss first with this investor? His need for liquidity.
The answer is . . .


Suitability--the dreaded HOLD recommendation.

As a registered representative, you have suitability obligations whenever you make a recommendation to a customer. A recommendation could involve telling someone to buy a security, to sell a security, or even to hold a security. Therefore, you wouldn't send out a large-group email to 100s of customers telling them to hold securities unless you were sure that was a suitable recommendation for every recipient on the list.

Good news, not telling someone to sell a stock that you once recommended is not the same thing as a "hold" recommendation. A hold recommendation is an explicit recommendation to hang onto a particular securities investment.

Since a "hold" recommendation would not lead to a commission, I can't think of a good reason to send one out. Can you?
Get help on your Series 7 exam

Tuesday, August 19, 2014

US Treasury also Issues FRNs or Floating-Rate Notes

Even though buying a 2-year US Treasury Note was never a big risk, investors did face the risk of watching interest rates rise right after they buy. Buying new T-Bills every single week at auction is totally impractical for retail investors. Luckily, the Treasury now sells a floating-rate debt security whose interest rate re-sets each week based on the yield established through the weekly T-bill auction. Investors now don't have to worry if interest rates go up each week if they own a Floating-Rate Note, or FRN, since investors will receive whatever rate is established each week for 13-week Treasury Bill yields. The key facts on Floating-Rate Notes or FRNs include:

  • Interest payments on FRNs rise and fall, based on discount rates for 13-week bills.
  • FRNs are sold in increments of $100. The minimum purchase is $100.
  • FRNs are issued in electronic form.
  • You can hold an FRN until it matures or sell it before it matures.
  • In a single auction, a bidder can buy up to $5 million in FRNs by non-competitive bidding or up to 35% of the initial offering amount by competitive bidding.

Floating-Rate Notes or FRNs provide liquidity and protection against capital risk/default risk, and interest-rate risk.

Tuesday, August 12, 2014

SEC Announces securities fraud charges against the state of Kansas!

First, let's see the press release from the Securities and Exchange Commission's website:
Washington D.C., Aug. 11, 2014 — The Securities and Exchange Commission today announced securities fraud charges against the state of Kansas stemming from a nationwide review of bond offering documents to determine whether municipalities were properly disclosing material pension liabilities and other risks to investors. According to the SEC’s cease-and-desist order instituted against Kansas, the state’s offering documents failed to disclose that the state’s pension system was significantly underfunded, and the unfunded pension liability created a repayment risk for investors in those bonds. 
At first, this kind of headline might confuse someone studying for the Series 7. After all, aren't municipal securities exempt under the Securities Act of 1933 and the Securities Exchange Act of 1934? Yes, and yes. However, that just means they don't have to file registration statements with the SEC under the Securities Act of 1933 and don't have to file those annoying 10Q, 10K, and other reports that companies like SBUX and MCD have to under the SEA of 1934. Municipal securities are still securities and all securities are subject to anti-fraud statutes in the securities laws at both the federal and state level. Note that I didn't say every-thing is subject to the securities laws' anti-fraud statutes. I said all securities are. A fixed annuity is not a security, but a municipal bond or a Treasury Bond is still a security that is simply exempt from registration requirements. Big difference. The SEC already busted the chops of the State of IL, who has already implemented changes that involve making their own even worse pension fund situation clear to those buying their bonds. Kansas will likely follow suit, as they need to borrow money as much or more than any other state. Last thing they need is the SEC getting a federal court to prevent the State from issuing any bonds at all until they get their act together.Need help with your Series 7 exam?

Friday, April 18, 2014

Morgan Stanley Profits Surge 56%

As an investor, I look for consumer discretionary companies that do one thing really well (Krispy Kreme, Starbucks, McDonald's) or financial companies that make money from many different lines of business (TD Ameritrade, Wells Fargo). My investment in TD Ameritrade (AMTD) has been outstanding--up around 90% in about a year--and, fortunately, it happened right after I decided to take much larger stakes in a few companies' stocks as opposed to spreading a little bit of money among several dozen. I mean, if you're not comfortable investing $10,000 into a stock, why "play around" with $400? If it drops, it drops the same % for everybody, and if you happen to hit a double or triple, where are you on a $400 investment compared to an investment of $10,000? Reading the WSJ online article announcing Morgan Stanley's recent surge in income and profits, I noticed that broker-dealers can make money in many different ways. They can underwrite securities. They can open an affiliated wealth management firm. They can trade securities for big profits. And, of course, they earn commissions whenever their customers want to trade, which is often. All along the way, they earn bazillions on unused customer cash, which is largely why I bought so many shares of TD Ameritrade when interest rates were low--as rates rise, AMTD will make more money. Unless they don't. In any case, here are some highlights from the WSJ Online article: Morgan Stanley's net income rose to $1.51 billion from $962 million. On a per-share basis, which reflects the payment of preferred dividends, the firm earned 74 cents, or 68 cents excluding accounting adjustments. Analysts polled by Thomson Reuters had expected adjusted earnings of 59 cents a share. Revenue rose 10% to $8.93 billion. Excluding accounting-related adjustments tied to the firm's own debt prices, revenue increased 4% to $8.8 billion, exceeding analysts' average estimate of $8.52 billion. Not too bad, huh?

Thursday, April 10, 2014

Series 7 Sample Question: Taxation

Series 7 exam candidates scour the web for Series 7 exam sample questions. Let's take a look at the kind of question you might see on your Series 7 exam: Which of the following statements accurately explains an investor's "marginal tax rate"? A. It is the rate applied to qualified dividends and long-term capital gains B. It is the rate of tax paid on the last dollar of income earned C. It is the rate applied to all of the investor's ordinary income for the year D. It is the average rate of taxes paid, calculated by dividing taxes paid by taxable income EXPLANATION: as always, take whatever you are given in the question and use it to eliminate answer choices. Choice A is trying to confuse you--investors might pay 15% or 20% (or even 0%) on qualified dividends and long-term capital gains, but they don't pay their marginal rate. A is eliminated. B looks good, but let's make sure. Choice C doesn't have it right, either--if somebody makes enough money to be pushed into the 33% bracket, that rate only applies to some of his income. C is eliminated. And, Choice D is defining the investor's effective tax rate. Choice B is the answer. An investor who tops out in the 33% bracket also pays 10, 15, 25, and 28% on various swaths of his income. He pays 33% on the "last dollar of income earned."

Wednesday, April 9, 2014

Can My Broker-Dealer Stop My Customers From Following Me to My New Employing Member Firm?

Can your employing broker-dealer prevent you from bringing your customers with you to your new employing member firm when you leave for a better opportunity? Yes. Can your employing broker-dealer stop your customers from transferring their account to your your new employing member firm? Absolutely not. See the difference? As FINRA explains perfectly in a Notice to Members, "As a condition of employment, certain members require their registered representatives to sign employment contracts in which each registered representative agrees that when he or she leaves the firm, he or she will not take, copy, or share with others any firm records. In addition, the registered representative may agree that, for a certain period of time following his or her departure from the firm, he or she will not solicit the firm's customers for business. Nonetheless, when a registered representative leaves his or her firm for a position at a different firm, clients serviced by the registered representative may decide to continue their relationship with the registered representative by transferring their accounts to the registered representative's new firm." The specific rule that prohibits interference with a customer's decision to transfer the account in such cases is FINRA 2140. Since you wouldn't otherwise be able to sleep tonight, I'll go ahead and reproduce that rule for you here: No member or person associated with a member shall interfere with a customer's request to transfer his or her account in connection with the change in employment of the customer's registered representative where the account is not subject to any lien for monies owed by the customer or other bona fide claim. Prohibited interference includes, but is not limited to, seeking a judicial order or decree that would bar or restrict the submission, delivery or acceptance of a written request from a customer to transfer his or her account." So, if you leave your firm for greener pastures, please do not violate your employment contract by poaching customers or--probably worse--walking out with their account information on a little thumb drive. But, if your customers decide to move their account when you make your move, your firm cannot play hardball with them and try to interfere with an ACAT transfer.