What Kind of Questions Are on the Series 65 or Series 66?

Are you comfortable with a question like this?

The definition of "expected return" would relate to which of the following?
A. Sharpe ratio
B. CAPM
C. Beta
D. Term life insurance

Okay, step one--what kind of return does one expect from a life insurance policy that has NO CASH VALUE?
None--eliminate Answer Choice D just because it's kind of smart alecky and sticks out like a sore thumb. Okay, Beta doesn't really try to predict, and isn't a "return" measurement. It just tracks the movement of one part of the index with the overall index--is MSFT more volatile or less volatile than the overall index it belongs to? About even, as it turns out, which is not the point--the point is, eliminate Answer Choice C. Excellent, now you're sitting 50-50. Unfortunately, this is where many of my tutoring clients blow it. They're tired now, cranky. They don't LIKE the Series 65 or Series 66. Uh-huh. I didn't like reading all the new crap from Dodd-Frank, but it seemed to be part of my job description, so let's stop wasting time here and get the job done. What is the Sharpe ratio? It's a risk-ADJUSTED return measurement. It measures the return that's already happened, adjusting it for the risk encountered. It can't possibly be predicting an EXPECTED return, right? So, even if you can't recall the definition of  CAPM (which is kind of lame, actually, but who cares), you simply eliminate Answer Choice A, and you win. CAPM measures expected return in a very interesting way--google the formula for extra credit. Need Series 65 Questions? Series 66?

What is a Brady Bond?

Some of you might see a question about Brady bonds, so let's cover it quickly here. First, these bonds are issued by developing/emerging market governments. Second, they are payable in US dollars. Third, they are often collateralized by US Treasury securities. Fourth, most issuers are Latin American nations. Finally, although these bonds are associated with emerging market issuers, they are among the safest bonds in that category. Need a Tutor?

What is a SOLE PROPRIETOR?

The trouble with being in business as a sole proprietor is that you remain personally liable for the debts and lawsuits against the business. You have not created a separate legal entity—you and the business are one and the same. If the sole proprietorship called Mary's Muffins accidentally sells ten dozen tainted blueberry muffins that send swarms of sick people to the ER, Mary is in a whole lot of trouble. All the lawsuits will be filed against her personally, and the creditors who used to spot her flour, oil, sugar, etc., are going to come after Mary personally for any unpaid bills. Also, some students seem to think the term "sole proprietor" means "no employees." Not at all. It just means that when it comes to the ownership of the business, there is only one individual human being, with no actual separation between him and his business. Believe it or not, some broker-dealers and many investment advisers are owned as sole proprietorships.  To protect assets, there is always insurance.  But, to be a sole proprietor without sufficient liability insurance for damages one might cause; that is risky business. I often marvel that as a high school and college student I owned a small, not-quite-lucrative carpet cleaning business. At one point, I called it Dunwell Cleaning, because that sounds like a business, doesn't it? It was really just an assumed name, and I had to publish a text ad in the local newspaper that probably no one in the greater Champaign-Urbana area ever read announcing that Robert Walker is now doing-business-as (DBA) Dunwell Cleaning. I received an assumed name certificate from the county so that I could open a bank account in my name "DBA Dunwell Cleaning" and customers could write checks to a business as opposed to some 22-year-old kid named Bob. The liability I took on entering people's homes, businesses, and sorority houses was actually huge in retrospect--I could have ruined thousands of dollars of carpeting, or maybe somebody trips over the extension cord I'm using on the second floor and gets seriously injured, or maybe some hysterical customer calls at 2 AM screaming that her children have been rushed to the ER due to an allergic reaction to the spot remover I sprayed all over the poor kids' bedrooms. Luckily, I was just smart enough to buy some liability insurance that would have paid out on some of those claims, although--now that I think of it--I had no assets at the time, so what the heck was I protecting? Anyway, if one does have assets (nice houses, cars, stocks, bonds, and annuities, etc.) one needs to think long and hard about doing business as a sole proprietor. Without the right insurance coverage, sole proprietors can easily end up losing everything they own over a lawsuit or bankruptcy filing. NEED HELP WITH YOUR EXAM?

Real estate is not a security? But an interest in a REIT is?

The title to this post is the title of an email I received from a Series 65 candidate who--like most people--is still struggling to get over the hurdle known as the Series 65 Exam. What stands out to me is this--her question actually explains THE point when trying to determine if an investment is actually a "security." But before I go there, let's first ask the more important question: why does the test ask me if something is or is not a security? Because of two things: the anti-fraud statutes, registration requirements. If the investment is not a security, the Uniform Securities Act has no authority over it, period. For example, you cannot commit securities fraud when offering/selling a fixed annuity--it's not a security. But, a mission investment fund security offered by a religious organization--Lutheran, Catholic, etc.--does meet the definition of a security. It is, therefore, subject to anti-fraud rules, and if investors are sold securities based on insufficient or erroneous offering documents, that is securities fraud. The security is exempt from the registration requirements of the Uniform Securities Act, but all SECURITIES are subject to the Uniform SECURITIES Act. And, the Uniform SECURITIES Act doesn't cover fixed annuities any more than it covers baseball cards.
Or, does it cover baseball cards?
I don't know--tell me more. If we're talking about some guy with a shoe box full of rare and valuable baseball cards, we're definitely talking about somebody with something of value--an investment of money that has likely gone up in value over time. But baseball cards are tangible items, things. Securities are always intangible. This piece of paper represents a debt obligation of a corporation; this piece of paper represents an ownership stake in a C-corporation trading on the NYSE, etc. So, a baseball card collection is an investment of money in collectible items--not a security. We could use baseball cards, on the other hand, to create an investment of money that would meet the definition of a "security."  Using the criteria from the Howey Decision, what would we call a situation in which 27 investors put $25,000 into an enterprise that uses that infusion of capital to travel the country going to baseball card swaps. Each investor receives a 1.5% ownership stake of any net profits/dividends. We don't call it "stock" or anything like that? Well, no one cares what it's called.  The question is--how does it function? It functions as an investment of money in a common enterprise where the investors profit solely through the efforts of others. It's an investment contract, which is a security.
Similarly, if you purchase a commercial building--which I so do not recommend--you have invested in real estate. This is not a security. However, if you put together a bigger real estate program funded by investors who put in money in exchange for an equity/ownership stake, now you have created a security. Chances are, you have created a REIT (real estate investment trust), in which investors will receive a share of net income, assuming there is any. So, the customer's email was perfectly titled--real estate is just real estate. If you sell ownership interests in a real estate program--now you're talking about a security. Need Help with Series 65/66?

What the Heck Is a Willful Violation?

Let's see how the Uniform Securities Act explains the meaning of the term "willful violation." The notes to the USA state: As the federal courts and the SEC have construed the term “willfully” in § 15(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78o(b): all that is required is proof that the person acted intentionally in the sense that he was aware of what he was doing. Proof of evil motive or intent to violate the law, or knowledge that the law was being violated, is not required. So, don't think for a moment that a willful violation occurs because the person clearly knew he was violating the law or maybe even the specific statute.  No, no, no. The so-called "investment adviser" was not declared mentally incompetent at the time she created a little-pretend family of mutual funds. So . . . she obviously knew the "mutual fund investments" she was "selling" to people were bogus. Willful violation. Of course, the New Jersey Bureau of Securities took away her license as an RIA. . . more importantly, the attorney general's office got a plea bargain out of her in a criminal proceeding leading to PRISON time. For more on this case, see http://www.nj.gov/oag/newsreleases08/pr20080429c.html.

But, that's just ONE example of a "willful violation." A "willful violation" could involve a financial planner getting her license revoked by the state but continuing to offer and provide financial planning services, anyway. That could--believe it or not--lead to criminal penalties. But that would be highly unusual.

The Uniform Securities Act  makes it clear that one can defraud an investor without any intent to defraud. Through negligence, incompetence, or breach of fiduciary duty, you can be sued and/or lose your license, but it's not a crime to buy somebody an inappropriate security. It's just often a career-ender. Check out what the Uniform Securities Act has to say at the very beginning: Part I Fraudulent and Other Prohibited Practices

Sec. 101. [SALES AND PURCHASES.] It is unlawful for any person, in connection with the offer, sale or purchase of any security, directly or indirectly

(1) to employ any device, scheme, or artifice to defraud,

(2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or

(3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.

OKAY, notice the last two lines under (3)??That means that a sloppy/incompetent/negligent person can violate the securities laws of the state by "engaging in a course of business which does or would operate as a fraud." How? Because the dude is so incompetent that all investors likely get bad information or no information. He's not going to jail; he's just going into a new industry at his earliest convenience. For example, a few years ago a new registered representative in Illinois had an elderly client who wanted "government bonds for safety and income." Dude bought her government bonds . . . issued by Honduras and Nicaragua. Was the investor defrauded? Yes. Did the dude go to jail? No. And since he didn't mean to hurt anyone, he's still a registered representative, right? Wrong. He acted in a way that operated as a fraud on the investor. He's not a criminal; he's just incompetent. And now, he's in a new line of work, hopefully one more suited to his particular skill set.

Cash Flow

A company reports its net income after tax (net profit) on the income statement. That net income is reduced if the company is subtracting large amounts for depreciation/amortization. If a company bought a printing press for $1 million cash a while ago, they might be subtracting $100,000 a year until they've written down the cost to zero, in order to spread the cost over the useful life of the equipment. But those subtractions now are not cash--they are a reality check. Since depreciation/amortization is a non-cash subtraction on the income statement, analysts often add back that subtraction to the net income in order to estimate how much cash the company is generating.

In the 10K, the company shows its balance sheet and income statement, and also a statement of cash flows. There are three ways a company can use or generate cash each year: operations, investing, financing. A company can generate or use up cash operating its business, but also by investing in equipment (or selling it off) or issuing securities (or buying them back). So, if the company's cash position increases, analysts would note perhaps that it's simply due to a recent offer of stock or convertible debentures (financing). If the cash position drops this year, maybe it's only because the company wisely invested cash into better equipment (investing). For extra credit "google" a public company's 10K and read thru the consolidated financial statement and the notes to it. It could REALLY help you on a few test questions. NEED HELP with your exam?

Self-Directed IRAs and 401Ks

Some folks might pretend they know the ins and outs of all available retirement plans, but that is not likely. For example, few people know that within an IRA account, an individual can actually invest in real estate, private placements, notes, and other investment options far outside the typical CDs and mutual funds. Self-directed IRAs allow individuals to invest in the typical securities investments that typical IRAs do but also expand into real estate, or possibly even providing start-up capital to a speculative company. Only certain companies can act as the administrator for the self-directed IRA account, but you can certainly find a few if you google the term "self-directed ira" or "self-directed 401K." I guess if I were impressed with my returns on real estate thus far, I might consider switching my Traditional or my Roth IRA to a self-directed account. But, since I prefer to buy REITS to financing and managing my own properties, I will continue to let my current broker-dealer/custodian hold the assets. But, who knows, some investors may want to explore the opportunity of investing in, for example, real estate or start-up companies. The test might even bring up the expanded investment options allowed in "self-directed IRAs" or "self-directed 401Ks."more help CLICK here