Securities Industry Essentials Exam

The SEC (Securities and Exchange Commission) is the federal government agency responsible for enforcing securities laws, regulating the securities industry, and protecting investors. It was created by the Securities Exchange Act of 1934.

FINRA (Financial Industry Regulatory Authority) is a self-regulatory organization (SRO) that oversees broker-dealers and their registered representatives. While the SEC has broad authority, FINRA handles day-to-day regulation including licensing exams, member firm inspections, and disciplinary actions. FINRA operates under SEC oversight but is not a government agency.

The primary market is where new securities are issued and sold for the first time. When a company conducts an IPO or issues new bonds, these transactions occur in the primary market. The issuer receives the proceeds from primary market sales.

The secondary market is where previously issued securities are bought and sold between investors. Stock exchanges like the NYSE and Nasdaq are secondary markets. The original issuer does not receive proceeds from secondary market transactions -- they flow between buyers and sellers.

Bond prices and yields have an inverse relationship. When prevailing interest rates rise, existing bond prices fall because newly issued bonds offer higher coupon rates, making older bonds less attractive. Conversely, when interest rates fall, existing bond prices rise.

This is one of the most fundamental concepts in fixed-income investing. For example, if you hold a bond paying 3% and new bonds are issued at 5%, your bond's market price will decrease to make its effective yield competitive with the new issues. Longer-term bonds are more sensitive to interest rate changes than shorter-term bonds -- a concept known as duration risk.

A call option gives the holder the right, but not the obligation, to buy the underlying security at a specified strike price before the expiration date. Call buyers are bullish -- they profit when the underlying asset's price rises above the strike price plus the premium paid.

A put option gives the holder the right, but not the obligation, to sell the underlying security at a specified strike price before the expiration date. Put buyers are bearish -- they profit when the underlying asset's price falls below the strike price minus the premium paid.

Options have two components of value: intrinsic value (the amount an option is in-the-money) and time value (the premium above intrinsic value reflecting time remaining until expiration).

Regulation T, set by the Federal Reserve Board, requires investors to deposit at least 50% of the purchase price when buying securities on margin. This is the initial margin requirement.

After the initial purchase, the account must maintain a minimum equity level known as the maintenance margin, which is typically 25% of the current market value of the securities (though many firms set higher house requirements of 30-35%). If the account equity falls below this level, the investor receives a margin call and must deposit additional funds or securities to bring the account back into compliance.

Insider trading is the illegal practice of trading securities based on material, nonpublic information (MNPI). It is prohibited under SEC Rule 10b-5, which makes it unlawful to use any manipulative or deceptive device in connection with the purchase or sale of any security.

An "insider" can be a corporate officer, director, or employee, but the prohibition extends to anyone who possesses and trades on MNPI -- including friends, family members, or business associates who receive tips. Both the person who provides the tip (tipper) and the person who trades on it (tippee) can be held liable. Penalties include fines up to three times the profit gained or loss avoided, plus criminal penalties including imprisonment.

The Securities Act of 1933 (also called the "Paper Act" or "Truth in Securities Act") primarily regulates the issuance of new securities in the primary market. It requires that investors receive financial and other significant information about securities being offered for public sale, typically through a prospectus. Its focus is on disclosure and preventing fraud in the sale of new securities.

The Securities Exchange Act of 1934 (also called the "People Act") regulates the secondary market -- the trading of securities after their initial issuance. It created the SEC, established rules for exchanges and broker-dealers, and includes anti-fraud provisions such as Rule 10b-5. A helpful mnemonic: 1933 = new issues (3 comes first, like the primary market); 1934 = secondary trading (4 comes second).

Form U4 (Uniform Application for Securities Industry Registration or Transfer) is used to register individuals with FINRA member firms, other self-regulatory organizations, and jurisdictions. It collects personal information, employment history, disclosure questions about criminal history, regulatory actions, customer complaints, and financial events like bankruptcies.

Form U5 (Uniform Termination Notice for Securities Industry Registration) is filed when a registered person leaves a firm, whether voluntarily or involuntarily. The firm must file the U5 within 30 days of termination. The U5 includes the reason for termination and any updated disclosure information. Both forms become part of the individual's permanent record accessible through FINRA's BrokerCheck system.