Thursday, January 20, 2011

So Everything is Subject to Anti-Fraud Provisions?

Every SECURITY is subject to the Uniform Securities Act's anti-fraud provisions. Some securities are exempt, and some are sold thru exempt transactions. Those securities don't have to be registered. But they are still securities, so if they are sold deceptively, the anti-fraud provisions apply. The folks who put out bogus offering documents, misstating important facts and leaving out important negative information, can be prosecuted and/or sued.
But--and the test is exactly this tricky and mean--if the investment is NOT A SECURITY, it is not subject to anything under the Uniform Securities Act. Therefore, the test could ask you whether a fixed annuity or whole life insurance would be subject to the anti-fraud provisions. The answer?
Why?They're not securities. But a Treasury bond, a municipal bond, or a church bond--though they don't have to be registered--are all securities. Therefore, they are still subject to the Uniform Securities Act's anti-fraud provisions.
And then the securities that are not exempt (non-exempt securities) are not only subject to the anti-fraud provisions, but also they have to either be registered with the Administrator or sold through an exempt transaction.
That way the regulators can keep things the way they like them--nice and simple.

Monday, January 17, 2011

What in the world is a church bond?

When you're reading the Uniform Securities Act, it's easy to look at the information as if somebody just made it all up. In the live classes, people sometimes stop me and ask something like, "Whoah, hold on, Bob--a church bond? What the heck is a church bond?" Here goes. Religious organizations frequently raise money by selling debt securities to investors. I have an offering circular on my desk for a $240 million offer of various debt securities by a Lutheran organization that funds various missions. The offering is for the "mission investment fund," and on the front page of the offering circular we see that these securities have not been registered with the SEC in reliance on an exemption under the Securities Act of 1933 . . . but that this does not imply that any regulator has approved (or disapproved) of the securities, and any statement to the contrary is a criminal offense.
What does that mean? It means these debt securities do not have to be registered, period. But to raise $240 million, the organization has to disclose to investors all kinds of financial information. If any of that information is deceptive, this offer of securities is still subject to anti-fraud regulations, meaning the organization could face criminal prosecution and civil lawsuits. If the offering circular overstates the amount of money taken in through collections or bequests, that's a mistatement of a material fact. If the document leaves out some bad news that might have made investors think twice, thats' an ommission of material fact. So the offer of these securities is definitely subject to anti-fraud statues. It's just not subject to registration.

Sunday, January 16, 2011

Series 65 Exam

The Series 65 Exam is not known for changing drastically year-by-year. When something major is changed, NASAA announces it with plenty of lead time. For example, in 2010 they warned everyone early on that the outline was being changed and--worse--the passing score was being bumped up from 68.5% to 72%. This year, we don't see any announcements from NASAA about the Series 65 exam or the Series 66 exam. But, the industry itself is implementing some changes that will start showing up on the exams by the middle of this summer. We won't worry about them much now, but in a few months, the following will be considered testable:
  • federal covered advisers will need $100 million in AUM
  • form ADV Part 2 is changing formats to a narrative (vs. checkbox) form
  • form ADV Part 2 will have a Part A and Part B
  • ADV Part 2B is for disclosure related to IARs working with customer accounts

Saturday, January 15, 2011

Series 65 Sample Question

Best way to prepare for the Series 65/66 exam is to take and analyze practice questions. Notice how I said "take AND analyze." Too many candidates focus on trying to get a particular score on practice questions. It's much more important to learn from the practice questions. In fact, you should probably keep a notebook just for taking notes on what you can learn from working through practice questions. Like this one:

An annuitant chooses the settlement option known as "life with 10-year period certain." The annuitant dies 13 years later; therefore,
A. the annuity stopped paying after 10 years
B. the annuity stops paying when the man dies
C. the annuity pays the beneficiary another three years
D. the beneficiary receives the cost basis only

EXPLANATION: "life with 10-year period certain" means that either the annuitant or the beneficiary will receive at least 10 years of payments . . . and, if the annuitant lives longer than 10 years, the annuity will pay until he, you know, dies.


Real-World Low-Level Felonies

A willful violation of securities law is just what it sounds like--you violated the law and can't reasonably claim there was no way for you to know it was, like, a bad idea. For example, let's say you owned a bar and grill and wanted to raise money to build an addition to the restaurant. If the local bank shuts you down, you might start asking customers if they want to invest $5,000 each in exchange for 2% of the profits. You might not call the investments "stock," but the regulators would consider them to be investment contracts, which are securities. If you didn't register them, they can refer you to a criminal prosecutor (Attorney General, District Attorney, State's Attorney, etc.) who might want to charge you with some low-level felonies for selling unregistered securities through unregistered agents. Would they go that far? They might. Maybe some of your investors complain to the regulators that you didn't disclose the following material information:
  • your restaurant was on the verge of bankruptcy
  • the addition could only be built if granted a zoning variance
  • you intended to use some of the $ for a new Cadillac Escalade
  • your restaurant has never made a profit
Oopsie. Now, we're talking about multiple counts of felony charges like "securities fraud" or "omissions and misstatements," etc. on top of the unregistered securities and selling thru unregistered agents. The Uniform Securities Act's little "3 years/$5,000" criminal penalties are just for the little pretend Uniform Securities Act. The lowest-level felony in Alabama, for example, a "Class C felony," carries a sentence of anywhere between 1 and 10 years and a $15,000 fine! In IL, a Class 4 felony carries a sentence between 1 and 3 years, and/or a $25,000 fine. Wow. So, if a smarmy businessman takes people's money under false pretenses, the Administrator is not the problem. The problem would really be the possible criminal liability and also the civil liability to investors who end up suing him.

Estimating Probabilities

Believe it or not, a question as wacky as the following can and allegedly does show up on the Series 65/66 exams:

You have flipped a coin 100 times now. It has come up tails 68 times. If you flip the coin again, the probability of its landing "tails" is

A. 32%

B. 69%

C. 68.5%

D. 50%

EXPLANATION: I was tutoring a man who lives a few blocks from the Las Vegas strip. Man, did he have a hard time answering this question. "Well," he pushed back, "who's flipping the coin?" "What KIND of coin are we talking about here?" "Which casino is he in?"

Eventually, he--like you--figured out that if there are two outcomes, the probability is always 50%, period. End of story.

Also, note that if a coin turns up 7 out of 10 times heads, that is nowhere as freaky as a coin that comes up heads 650 times out of 1,000. The law of large numbers says that as the number of flips increases, the outcome should get closer to 50%. Why is this on the test? Financial planners talk about this stuff to help themselves understand why investing clients are so horrible at estimating and understanding risk.