Investment Risks

The Series 65/66 exams don't frequently reward test takers for the little factoids they've managed to memorize. Rather, the exams expect test takers to know the factoids only so that they can use them to think their way through some rather challenging questions. Like this one:

An investor is considering an opportunity to invest in wireless spectrum now that the FCC has forced large carriers to auction off a percentage of their capacity. Minimum investment is $50,000. The check will be payable to WiredAmerica, LLC, who will act as a representative for investors, negotiating charges for spectrum and helping to find equipment contractors and re-selling opportunities for investors once the deals have been finalized. Investors are advised to prepare for a 12 to 18-month waiting period before monetization opportunities commence. If the spectrum is not available, investors will receive their initial investment, less a 4% administrative fee. Which of the following statements is accurate?
A. the investment would not meet the definition of a "security"
B. the major risk to investors is loss of purchasing power
C. regulatory risk is not significant in this scenario
D. investors face regulatory and obsolescence risk

EXPLANATION: just reading this crazy question will set you back a few minutes at the testing center and probably increase your blood pressure a few points. If you're flabbergasted by something like this, choose "C" and mark it for review. Come back later after you get through the exam. Of course, you eventually have to deal with monsters like this, so, as always, see what you can eliminate. It's never crystal clear whether something is/is not a "security," but how can we rule this one out? It's an investment of money in which the investor plays only a passive role--sounds like the Howey Decision would apply. Eliminate Choice A. I guess if you turn your money over to these folks for a year/year-and-a-half, and then you get back only 96% of your principal, you've lost purchasing power. But, is that the major risk? Frankly, I'd be a lot more worried about waiting 18 months, then making a phone call only to discover the number has been disconnected. I don't like Choice B enough to choose it. The whole premise of this "investment opportunity" is that the FCC has required large wireless carriers to auction off spectrum that they currently hold--any chance that a Republican controlled House of Representatives might try to block that ruling? I would think so. Notice how it's hard to be certain on any of these three choices--your job is to see if you can eliminate Choice D. If so, you'll have to start all over. If not, choose it, confirm it, and keep moving. There definitely seems to be regulatory risk, and with wireless technology changing so rapidly, isn't there at least a chance that in 18 months the spectrum you thought was worth X is now only worth Y or maybe even worthless? Tough to eliminate Choice D. So, as often happens, you're not 100% sure of your answer, but it would still seem that D is the best choice.




ANSWER: d

Nobody Ever Makes any $ in Stocks, Right?

People often try to convince me that "nobody ever makes any money investing in stocks." What I take this to mean is that this dude has never made any money in the stock market and doesn't know anyone any smarter or luckier than himself.
Bulls*** nobody makes money in the stock market! I'm not just talking about geniuses like Warren Buffett or Jim Cramer; even folks who barely know what they're doing have been known to earn some decent returns. Like me, for example. The fact that I know the information likely to be tested on your Series 65/66 exam is not really an indicator that I know how to invest. But, apparently, I do. I mean, like all investors, I make some really bad judgment calls here and there, and often I simply can't remember what I was smoking when I hit the "buy" button, but, overall, I have made some pretty good returns in the stock market. This morning--a slow pre-Thanksgiving day--I'm looking through my various investment accounts and can not help but pat myself on the back a little. About 10 years ago, I invested $609 in a fallen "dot-com" stock known as Priceline-dot-com. Many of my friends figured I was crazy, but by ignoring their uninformed pessimism, I was able to look at the company's finances objectively, pull the trigger, and hang on for the next decade. Guess what the current value of that six hundred-and change is today?
$9,533. That's a paper gain (unrealized gain) of about 1,400%.
Now let's pause for the naysayers: what about your losses, though?
In this account, I am sitting on a couple of embarrassments. Why I ever purchased shares of DELL, I'll never understand and why I didn't SELL as soon as the shares swooned, I'll also never know. But, the fact is I'm sitting on an unrealized loss of about $1,966. There is also a paper loss of about $128 on GE, proving that big "blue chip" companies can suck just as much as unknown small caps. Fine, let's go ahead and subtract the two losses from the gain on Priceline, and I'm still up about $7,439 or about 1,220%. What about the other losses? There aren't any. The other positions show gains of:
ABT $515 (12%)
HSP $993 (53%)
ORCL $800 (134%)
HGT $27 (5%)

Maybe the point would be clearer if we put it this way: the Roth IRA (which I have not been able to contribute to for a while) is now worth over $20,000 . . . even though my total deposits into the account equal just $10,000. Sure, some would say, but it took eight years for your money to double. That's correct. And, it's also a compounded return of around 9% . . . in a period when the S & P 500 has shown absolutely miserable returns and interest rates on Treasuries remain around 2 flippin' percent!
So, I'm not ready to hang out a shingle and start managing other people's money. But if somebody tries to tell me that "nobody ever makes any $ in the stock market," I look forward to showing them this blog post. I'm just an English major who did a lot of homework. Imagine if I actually knew something about investing!

Exemptions for Persons

This is a follow-up to the previous post, so you might want to read "What's the Deal With Exempt Securities?" before reading this one . . . assuming you actually "want" to read anything connected to the Series 65/66 exam, that is. As we discussed in the previous post, an exempt security is simply a security that doesn't have to be registered. US Treasury securities, municipal bonds, insurance company debt obligations, etc. are all excused/exempted from the registration requirements of the Uniform Securities Act. They're still subject to anti-fraud rules, of course, but the issuers don't have to waste as much time and money completing the typical registration process. If there's nothing special about the security--it's non-exempt--the security always has to be registered.
Except when it doesn't. If it's offered and sold through an exempt transaction, then the security would not have to be registered in the typical manner. For example, if the issuer offers the investment to only 10 persons in the state, or offers it only to institutional investors, registration of the security is not required. And, if the individual in the test question represents the ISSUER of an exempt security, or represents the ISSUER in an exempt transaction, that individual does not have to register.
But, if the individual represents a broker-dealer by selling any securities, that individual has to register in any state where he has a place of business or any non-institutional clients. That seems to imply that the agent does not have to register in order to work with institutions, but that is not correct. The agent has to register with FINRA through the member firm to sell securities to any customer. Also, he has to register with every state in which he has a place of business or any non-institutional customers. If he has a place of business in New York and wants to open an account for a retail customer in Indiana, he has to be registered in Indiana. He would not have to register if he had no place of business in Indiana and the only customers there were institutions. No need for the additional registration in Indiana in that case, but that doesn't mean the agent doesn't have to be registered anywhere. Right?
If a broker-dealer has a place of business in Arkansas, they must register there. Period. If they want to serve retail customers in Louisiana, they have to register with Louisiana. If all their customers were institutions in Louisiana and the firm had no place of business there, no registration would be required by the state of Louisiana. No additional registration required in that case.
So, as always, read the questions carefully and think through them analytically. Also, hang onto the big concepts below:

• If an agent represents a broker-dealer, he has to register, period
• If an agent or broker-dealer has a place of business in the state, they have to register in the state
• If an agent or broker-dealer have no place of business in the state and no non-institutional customers, they do not have to register in that state

What's the Deal with Exempt Securities?

Maybe you've sat through one of the live classes that remain the bread and butter of the bigger vendors. If the instructor tried to teach the fundamentals of the Uniform Securities Act to you, chances are he made a lot of noise about "exempt securities" and "exempt transactions" but never quite explained what the terms mean and--more important--what they don't mean. When I used to teach for a big vendor in this industry, I had to use the sorry materials I was handed, and no matter how I tried to spin it, I could tell that many students walked out thinking the following:

• if the security is exempt, it is not subject to the Uniform Securities Act's anti-fraud statutes
• if the security is exempt, the agent doesn't have to be registered
• if it's an unsolicited order, an unregistered person at a broker-dealer can accept it
• if the customers are all institutions, the agent of the broker-dealer does not have to be registered

What the above four bullet points have in common is this: they aren't true. But, in the confusion of a four-hour Series 63 class or maybe a two-hour segment of a Series 65/66 class, it's very easy to understand why students would come out thinking that way. So, let's clear up some big points here. First, not every investment meets the definition of a "security," but if it is a "security," it is subject to the Uniform Securities Act's antifraud regulations, whether it has to be registered or not. A US Treasury note doesn't have to be registered, but if an agent offers one to me under false pretenses, that is still securities fraud. Second, all securities have to be registered except for all the securities that don't have to be. A security that does not have to be registered is an "exempt security," which means it's still a "security" subject to antifraud regulations. It just doesn't have to be registered. For example, US Government securities, municipal securities, bank securities, and highly rated commercial paper do not have to be registered. What about the agents selling them? If they work for a broker-dealer, they have to register. I mean, if agents selling municipal securities didn't have to be registered, why would there be a Series 52 for people selling municipal securities? A Treasury note doesn't have to be registered, but an agent of a broker-dealer selling Treasury notes to customers does have to be registered. The only time we care about whether the security is exempt is when the individual represents the issuer of that security and does not get special compensation to sell it. If the CFO of a company wants to essentially get a loan by selling commercial paper to an institution, she does not have to register. Or, even if the CFO wanted to sell an ownership stake in the company to institutions only, that would not meet the definition of an agent. But, again, if you represent a broker-dealer in selling securities, you have to be registered.

If a security is non-exempt, it still might escape registration if it's sold through an exempt transaction. This is the one case where an "unregistered, non-exempt security" can be offered and sold without getting in trouble. But, if you're an agent of a broker-dealer taking indications of interest for this offering, YOU have to be registered. You don't work for the issuing corporation, right?Again, if you work for a broker-dealer selling securities, you have to be registered. The security might or might not have to be.

So, if the test asked if an agent of a broker-dealer would have to register just to sell municipal securities to institutional investors, the answer would be . . . absolutely. Why? Because he's an agent of a broker-dealer. In the rare case where somebody works for the issuer of an exempt security or represents the ISSUER in an exempt transaction--getting no special compensation for the sales--that person escapes registration.