Wednesday, March 31, 2010

Stops, Limits, and Other Things Students Hate

A Series 65 customer just sent me a question by email:

Thanks for the tutoring on Saturday!! I am still a little unsure about the whole stop order and stop limit order. When do you want to use these ? Also does one make a bear market worse or a bull market better.. Also with the short sale... Are a lot of these a sign of a bull market...?

The following is my response to her inquiry:
Hi, Nicole

First, separate the sell limit order from the stop order. A sell limit order is placed at a price higher than the current market. Let's say the bid on ABC is $50, but you don't want to sell your ABC for anything less than $52. Place a sell-limit at $52. If the bid rises to $52, your stock is sold. If not, you keep holding. So there's no protection here. If the stock drops, it keeps dropping. You just want to sell it for a specific price or better/higher. The stock has to go up before it can be sold.

To protect your downside, place a sell-stop order. If you're holding ABC and the market price is $50, you could protect your downside by placing a sell-stop at, say, $49. If the stock stays above $49, you hold it. If it drops to $49 or lower, it is sold automatically. Notice how your upside is still wide open--you only sell to protect against a loss. That's why the order is also called a "stop loss" order. These can make a bear market worse because if the stock drops a little, a bunch of sell orders go off at the same time on autopilot.

If you turn this order into a sell-stop @49, limit 49, you no longer have protection. Why not? If the stock opens in the morning at $48.50, your order would be activated, but you're saying you won't accept one penny under $49. If the stock keeps dropping, the broker-dealer won't be able to sell it for you . . . not unless or until the stock makes it to $49 or higher.
So, to protect the position, enter just a sell-stop . . . don't add the word "limit." whenever the order has a " limit " price, it can only be executed at that price or better.

On a completely different note, a high level of "short interest" on a stock could be a BULLish indicator. If a big % of a company's stock has been sold short, it will also have to be bought back by the short sellers . . . that buying pressure could--maybe--raise the price of the stock. That's how technical analysts think--has nothing to do with the underlying company; it's based entirely on stock market data.

Wednesday, March 17, 2010

Broker-Dealers and Investment Advisers--Who's Who and What's What?

Remember that a broker-dealer is in the TRANSACTION business. As the Uniform Securities Act states, a broker-dealer is "any person engaged in the business of effecting transactions in securities for the account of others or for his own account." If the firm acts as a broker, they arrange a transaction for the accounts of others. If the firm acts as a dealer, they effect a transaction for their own account in which they buy from or sell to a customer. They work the secondary market, either arranging or participating in trades, and they work the primary market as investment bankers, bringing new issues to market in order to raise capital for government and corporate issuers. On the other hand, an investment adviser is not paid to complete securities transactions. An investment adviser, believe it or not, is compensated for providing advice on securities. This advice could be delivered in person or through reports and analyses. It could involve managing portfolios for a % of the assets, or charging a fee to act as a consultant or financial planner. The big financial services firms work both sides of the business, but they still register the broker-dealer as one entity and the investment adviser as another. For example, at Wells-Fargo, the structure is explained in their Form ADV 2 like this: Wells Capital Management Incorporated (“WellsCap”) is a registered investment adviser and a wholly owned subsidiary of Wells Fargo Bank, N.A. (“Wells Fargo"), which is wholly owned by Wells Fargo & Company, a diversified financial services company. If we go to the broker-dealer's website, we see that: Brokerage is offered through Wells Fargo Investments, LLC (member SIPC), a non-bank affiliate of Wells Fargo & Company. Now we see why the Uniform Securities Act exludes "banks, savings institutions, and trusts" from the definition of both broker-dealer and investment adviser. A bank may be related to a broker-dealer and /or investment adviser because they have the same parent, but they are only siblings. WellsCap is the adviser. Wells Fargo Investments, LLC is a broker-dealer. They are both siblings of Wells Fargo Bank, N.A., and all three have the same parent, known as Wells Fargo & Company. Three kids, all related, yet all distinct entities.
Yesterday, a young man came in for some Series 6 tutoring and was trying to figure out what some of the senior reps at NMFN are doing under "wealth management" and how it differs from what he'll be doing when he passes his Series 6 and 63. His question was prompted by my overview of the same mutual fund prospectuses he'll be handing out very soon to investors. As I explained to him, he will be selling investment securities products called open-end mutual funds to investors. He will be trying to "effect transactions in securities" on behalf of his broker-dealer, NMIS, who has a sales agreement with another broker-dealer called American Funds Distributors. After customers buy these investment products, money will be regularly deducted to cover management fees, which go to the investment adviser known as Capital Research and Management Company. As always, the broker-dealers get paid to effect sales of securities; the adviser gets paid a % of assets to manage the portfolio. The senior reps at NMFN, who get their Series 7 & 66, can work both sides of the business. They can sell mutual funds and annuities as securities agents of a broker-dealer. Or, when they work the wealth management/investment advisory side, they basically bypass the little product known as a "mutual fund" and simply put their clients' assets under management with a team of investment advisers. Average Joe and Joann, with maybe $100,000 to invest, are probably best served buying mutual fund products, in which their registered rep (of a broker-dealer) makes part of the sales charge and the ongoing 12b-1 fees. Big-Time Charlie and Charleene, with maybe $5 million to invest, are often best served by getting their own investment adviser/portfolio manager, who will charge a percentage of assets as opposed to calling them up twice a week to try and sell them something.
So, if the firm is selling securities to customers, they are acting as a broker-dealer. If the firm is managing the client's account for a % of assets, they are acting as an investment adviser. The big financial services firms work both sides of the business, but there are many firms that act only as broker-dealers or as advisers. For example, if I wanted to get directly into the financial services industry, I could easily become an investment adviser. All that would take is filling out Form ADV, paying $400 to the Secretary of State's office, and keeping better records than I've ever kept in my life. To become a broker-dealer, I would have to take a bunch of principal-level exams, become accepted as a member firm of FINRA, and somehow overcome the fact that I have no idea how a broker-dealer is actually run. It's a very unique and peculiar business model that requires all kinds of infrastructure. An "adviser" is really just anyone who can pass the Series 65, afford the licensing fees, and find enough clients willing to pay for the so-called "advisory" services. I could be your adviser without ever executing a trade--just charge you $1,000 a year to send you quarterly reports that tell you specifically what to do with your stocks, bonds, and real estate investments. If I were your broker-dealer, I'd be holding custody of your assets like a bank, and taking commissions every time you placed an online trade or told one of my rep's to buy or sell securities for you.
I was actually trying to keep this more concise. Sorry about that; I would have made it shorter if I'd had more time.

Thursday, March 11, 2010

Fun with Form ADV Part 2

There are several testable points concerning the adviser's disclosure brochure, which is usually just a copy of Form ADV Part 2. Let's look at a possible test question:

Which of the following is/are accurate of Form ADV Part 2?
I. it must be delivered within 48 hours after signing the advisory agreement with a new client
II. it must be delivered to existing clients requesting it in writing within 5 days
III. it must be filed with the Administrator
IV. it must be delivered to all prospects

A. I
C. I, IV

EXPLANATION: if this particular question showed up on the exam, it would be one of the hardest-hitting questions in the batch. Choice I looks good--but it's backwards; the disclosure contained in the brochure must be delivered 48 hours before you sign the agreement with clients, or at the time of signing if they have 5 days to cancel without losing any prepayment. Advisers offer to send the thing to existing clients, and if clients send a written request, advisers must send it within 7--not 5--days. In the old days ADV 2 did not have to be filed with the Administrator, but now it does. Finally, the brochure is not required if the client is a registered investment company or if the advice is considered "impersonal," meaning that it does not purport to be specific to individual clients.


You can view an actual ADV Part 2 at

Wednesday, March 3, 2010

The WRONG way to approach test questions

If you don't have our ExamCram Online Test prep for the Series 65 or 66, get it. Be sure to work the Power Quizzes, too, which is where the newest questions show up first. As you work through practice questions, try to avoid a common tendency that I just noticed again this morning. First, let's look at the practice question my customer is determined to get wrong:

Which of the following investments is exempt from the anti-fraud provisions of the Uniform Securities Act?
A. Treasury note
B. Federal covered security
C. Whole life insurance
D. None of the choices listed

My customer is convinced that "nothing is ever exempt from the anti-fraud provisions of the Uniform Securities Act." And that is almost true. However, if the thing in question is not a security, then it IS exempt from everything contained in the Uniform SECURITIES Act. Is whole life insurance (or a fixed annuity) a "security"? No. So whole life insurance/fixed annuities are exempt from the anti-fraud provisions of the Uniform SECURITIES Act. A T-note and a federal covered security are still securities, so even though they don't have to be registered, the people who sell them are subject to anti-fraud rules. Mislead me when selling IBM or a T-note, and you are subject to anti-fraud rules.
Why didn't my customer just pick "C"? Because he doesn't want to cooperate with the question. Rather than play along, he decided that whole life insurance is not an investment; therefore, the answer is D.
Hmm. If the question says "which of the following investments . . . " you can safely assume that it's not an arguable point whether all choices are investments--they are. Even if you wanted to make the argument, how could you? Where do you find the definition of "an investment" in any of the securities laws you've had to study? Is a fixed annuity an investment? I think so. Is it a security? No. Is a house a security? No. Is it an investment? Many people would say that it is.
But, why are you arguing? There is no one at the testing center with whom you can argue. You have to play along with the questions, or come back and try it again in 30 days.

Took the Series 66 Yesterday

So I took the Series 66 exam yesterday, just for fun. Looked pretty much like the Series 65, only shorter. Bigger focus on the Uniform Securities Act and various NASAA model rules and policy statements. Smaller focus on securities products. As their vague outline indicates, they focus on variable annuities, options, and life insurance under their little "investment vehicle characteristics" section. Expect 5 basic options questions, 5 on variable annuities, and 2 or 3 on insurance. They mentioned "capital needs analysis" twice, which I'm sure will please you insurance folks no end.

The only way I can feel confident that you're prepared is if you get and use the Pass the 66 ExamCram online test prep at If you're on a time crunch, go straight to the "Power Quiz." I will continue to add timely questions to that one, even after you purchase the product.

Also, you will need to be intimately familiar with the following NASAA model rules/policy statements: