An effort to stay one step ahead of regulators. The reps would leave the firm just prior to FINRA expelling their broker dealer. The expelled or barred broker dealer becomes known as a sanctioned or disciplined firm. These representatives often engaged in high pressure sales tactics usually involving low priced penny stocks. Questionable broker dealers would higher these reps to continue the abusive sales practices. In an effort to combat this practice FINRA established the Taping Rule. A firm that is subject to the taping rule must implement special written procedures and begin taping the conversations of its registered personnel and customers within 60 days of being notified by FINRA that the firm has become subject to the taping rule. The firm also must implement written procedures to retain, review, and classify the recordings. Firms that fall into the following categories must tape their employees:

• Has more than five but fewer than 10 registered representatives and 40 percent or more have come from disciplinary firms within the last three years.
• Has at least 10 but fewer than 20 registered representatives and four or more have come from disciplinary firms within the last three years.
• Has 20 or more employees and at least 20 percent have come from disciplinary firms within the last three years.

A broker dealer that has been notified by FINRA that it is subject to the taping rule has a one- time option to reduce its number of registered representatives. If the firm elects to reduce a portion of the subject agents to eliminate the taping requirement, the firm may not rehire the subject agents who were eliminated for 180 days. Also, the firm may not hire additional agents to dilute the percentage of agents with disciplinary histories to avoid the taping requirement. All calls between Registered employees and customers or potential customers must be recorded. Exempt from the rule are internal calls and calls from employees who are not talking to customers.

FINRA definitely wants you to know a lot about CMO advertising, disclosures and suitability. A collateralized mortgage obligation (CMO) is a mortgage-backed security issued by Government- sponsored entities (such as Fannie Mae and Freddie Mac), broker-dealers and private finance companies . The securities are structured much like a pass-through certificate and the terms are set into different maturity schedules, known as tranches. Pools of mortgages on one to four- family homes collateralize CMOs. Investors in most CMOs receive monthly interest and principal payments based on the mortgage payments made by the homeowners. CMOs issued by Fannie Mae and Freddie Mac have largely had their credit risk offset through government guarantees. However, private label CMOS issued by broker-dealers carry the credit risk of the issuing entity even if all of the mortgages in the pool have been insured by government entities. Changing interest rates will impact the price of the CMO and the cash flow received by the investor. As interest rates change, homeowners tend to refinance homes based on the prevailing market rates. If interest rates rise, refinancing activity slows and in times of falling rates, refinancing activity accelerates. As a result the expected life and the ultimate yield for the CMO is subject to change. All retail communications relating to collateralized mortgage obligations must clearly disclose this fact to investors. Specifically, the communications must contain statements advising the client that the information regarding the yield and life of the CMO is based on certain prepayment assumptions and that those assumptions may or may not be met. To ensure that these required disclosures are included in print advertisements FINRA has created a standard CMO advertising template for use by member firms. Broker-dealers are free to use this template or to create their own provided that all of the required disclosures detailed in FINRA’S template are included. Television and radio advertisements are required to contain the same disclosures that appear in the template. Further, broker-dealers are required to provide retail investors with educational material covering the performance and risk characteristics of CMOs. This material must detail the impact changing interest rates have on CMOS, an explanation of the various tranches and a glossary detailing the relevant terms used. Because of the unique characteristics of CMOS, CMOS may not be compared to other interest-bearing investments such as bonds or other debt securities. Additionally, there are specific disclosures which must be made on a customer’s confirmation. The nominal face value, nominal yield, anticipated average life and yield, final maturity date, the specific tranche, CUSIP number if assigned and underlying securities must be disclosed on a customer’s confirmation.

The personal trading of analysts is highly regulated and closely supervised by the firm and by regulators. Many analysts are very influential. Their opinions and research reports can dramatically impact the price of a stock. In order to ensure that analysts who issue research reports do not profit by trading the security just before or after they issue the report, the following rules have been enacted:

• Analysts may not trade against their recommendations.
• An analyst who is working on a research report may not trade the security that is the subject of the report until such time as the intended recipients of the report have had an opportunity to act on the report.
• Analysts may not receive pre-IPO shares from a company in a sector the analyst covers.

The personal trading rules apply to accounts owned by the analyst or under the control of the analyst or any member of the analyst’s household. Exceptions would be made for hardship or emergency sales by analysts. Each exemption would have to be approved by the firm’s legal or compliance department. It’s important to note that a hardship exemption would not allow the analyst to trade against their own recommendation to cover expenses they knew were coming up, such as college tuition. Analysts may invest in mutual funds without restriction so long as the analyst does not own 1 percent or more of the fund and the fund does not invest more than 20 percent of its assets in a sector covered by the analyst. A broker dealer may prohibit analysts from owning securities issued by the companies or in the sector covered by the analyst. Should a broker dealer hire an analyst or assign a company to an analyst who already owns the stock in the company or sector they are now going to cover, the broker dealer must handle the sale of the securities in line with its policy of not allowing an analyst to own such securities.

A free writing prospectus is any form of written communication published or broadcast by an issuer which contains information about the securities offered for sale that does not meet the definition of a statutory prospectus. Common examples of a free writing prospectus include:

• Marketing materials
• Graphs
• Term sheets
• Emails
• Press releases

The free writing prospectus should include a legend recommending that the individual read the statutory prospectus to obtain more information relating to the securities being offered. A hyperlink will be used in many cases to direct the reader to the statutory prospectus. If the free writing prospectus has been erroneously distributed without a legend, the broker dealer should amend the free writing prospectus to include the legend and resend to recipients as soon as practical. An issuer who meets the definition of a well-known seasoned issuer may use an FWP at any time before or after the filing of a registration statement. A seasoned issuer may only use an FWP after the filing of the registration statement with the SEC. An unseasoned or non- reporting issuer may use a free writing prospectus only after a registration statement is filed with the SEC and must either send a statutory prospectus with FWP or must include a hyperlink to a statutory prospectus. Issuers who use free writing prospectuses will file them with the SEC over the SEC’s website.

These types of bonds are not bonds in the traditional sense like the ones investors purchase to earn interest income. Fidelity and surety bonds are more line insurance policies designed to protect against certain events. FINRA member firms are required to obtain a fidelity bond that covers the firm’s officers and employees. The purpose of the fidelity bond is to protect the firm’s customers from:

• Fraudulent acts
• Loss of securities
• Check forgery
• Securities forgery

The fidelity bond does not cover broker dealer bankruptcy or losses incurred as a result of errors or omissions. The required amount of the fidelity bond is based on the firm’s net capital. The minimum required fidelity bond coverage is 120 percent of the firm’s net capital for firms whose required net capital is less than $600,000 with a $25,000 minimum. The minimum fidelity bond requirement is based on 120 percent of the firm’s highest net capital requirement during the preceding 12 months. All firms must review their fidelity bond coverage annually and must make any required changes to the coverage within 60 days of the anniversary date of the bond’s issuance. For firms whose minimum required net capital is greater than $600,000, the minimum required fidelity bond coverage is $750,000. The minimum required coverage increases to a maximum of $5,000,000 for a firm whose minimum required net capital is greater than $12,000,000. If a broker-dealer makes a substantial change to its blanket fidelity bond or if the coverage is terminated, the broker-dealer must immediately notify FINRA in writing. Exchange members such as designated market makers and floor brokers who do not conduct business with the general public are exempt from the fidelity bond requirements.

A surety bond on the other hand primarily ensures a broker dealer’s financial solvency. It is used to guarantee that a broker dealer can meet its financial obligations. Many states require broker dealers to post a surety bond as a condition of state registration. On the series 24 exam you are most likely to encounter questions about fidelity bonds. The key test points are covered above.

A broker dealer’s net capital requirement is based on its business activities and the relationship of aggregate indebtedness to its net capital.. The question you refer to is frequently seen on the series 24 exam. First you need to know that a broker dealer’s minimum capital requirement to qualify as a market maker is $100,000. Its maximum capital requirement based solely on its market making activities is capped at $1,000,000. With that said the question often centers around the number of securities the firm is making markets in. The capital requirement for each security is as follows:

• $2,500 for each stock with a bid price of $5 or more
• $1,000 for each stock with a bid price of less than $5

A typical series 24 question will provide you with the number of securities the firm makes markets in and information on the price of the securities. The question will be laid out as follows:

ABC broker dealers is an active market maker. The firm makes markets in 350 equity securities. 250 of these are trading with a bid of $5 or more. What is the firm’s capital requirement based on its market making activities ? the math is easy enough 250 securities x $5 = $125,000. The question implies that the remaining 100 securities are priced below $5 per share and are therefore subject to $1,000 requirement. 100 X $1,000 = $100,000. As a result ABC broker dealers has a capital requirement of $225,000 based solely on the market making activity.

Most series 24 test takers will see an application style question on this very subject. A haircut is a deduction taken from the market value of securities in inventory for the purpose of determining net capital. A haircut is taken to allow for the volatility in securities prices and to reflect the fact that positions held in inventory may be off set at prices that are somewhat different from current market prices. Haircut deductions are 15 percent of the net long or short positions for securities traded on an exchange and regulation T OTC marginable securities and OTC securities with 3 or more market makers excluding the market maker doing the capital computation. Haircut deductions on other stocks with a limited market (one or two independent market makers) are 40 percent on both the long and short positions.Unregistered securities under the Securities Act of 1933 or those with no ready market receive a 100 percent haircut (no value given in computation of fi rm’s net capital). An additional haircut of 15 percent is applied to proprietary positions of a broker dealer on the market value of a stock in excess of 10 percent of its tentative net capital if the concentration limit is held for more than 11 business days. Th is is known as undue concentration. Tentative net capital is the broker dealer’s net capital prior to haircut deductions. The additional 15 percent haircut is applied only to the amount of securities in excess of 10 percent of the tentative net capital.

A riskless principal transaction for regulatory purposes is treated as if the transaction was executed on an agency basis. If a brokerage firm receives a customer order to buy or sell a security and the firm does not have an inventory position in the security, the firm may still elect to execute the order on a principal basis. If the firm elects to execute the order on a principal basis, it is known as a riskless principal transaction. Because the dealer is only taking a position in the security to fill the customer’s order, the dealer is not taking on any risk. As a result, the markup or markdown on riskless transactions will be based on the dealer’s actual cost, not on the inside market. Let’s look at an example: Let’;s say the market for ABC is $10 X $10.20. A client gives the firm an order to purchase 1,000 shares of ABCD at the market. The trader goes into the market and is able to purchase the stock for the firm’s account at $10.10. The firm immediately uses the stock in its inventory account to fill the customer’s market order. The customer’s markup will be based on the firm’s actual or contemporaneous cost of $10.10. The rationale behind this is clear. The firm did not take on any risk and therefore is not entitled to earn any extra profit on the transaction.

The NASDAQ market systems are heavily tested on the series 24 exam. This section tends to be the most challenging and in many cases the most frustrating for students. Most series 24 test takers are not sitting on trading desks. In fact most have never even seen one. In order to pass the series 24 exam you have to be a master of this information and demonstrate a level of understanding equivalent to a seasoned NASDAQ trader. The easiest way to differentiate ACT from TRF is to explain the concept using an every day scenario. Lets say you need to place an order on Amazon to buy a few household products. Once the products are in your cart you fill out the order form. You enter your name, shipping address, email address and payment information. You press the order button and the information is transmitted to Amazon. The next step takes place in the backend where Amazon’s merchant account charges your credit card and processes the order to ship you your products Simple, right? The TRF and ACT system function in exactly the same way. Instead of ordering products from Amazon and entering your details on a check out form, the TRF is an on screen “form” where traders can report the details of a trade. I.e bought 1,000 shares of XYZ at 42.15 from JP Morgan. When the trader hits the submit button the information is transmitted to the ACT system. In the backend the ACT system functions in a similar fashion to Amazon’s merchant account. ACT facilitates the clearing of the transaction. It facilitates the exchange of cash and securities between the buyer. Any transaction executed electronically is automatically reported to the ACT system ACT reports trades to the tape, matches and clears. ACT only plays a role after a trade is executed. It does not display, route or execute orders.

All broker dealers are required to report their financial status to the SEC and to FINRA. Firms file the report of their financial status on a Financial Operational Combined Uniform Single Report, more commonly referred to as a FOCUS report. It sometimes helps students better understand the concept if they think of how and when individuals file tax returns. A young person just out of school who does not have a lot of deductions or writeoffs will file a simple tax return on form 1040 EZ. An older, more established person whose income and deductions are more complex will file a long form 1040 to file his / her tax return. It is similar to the way firms file FOCUS reports. Introducing broker dealers who do not have custody of customer assets have a much less complex business than a general securities broker dealer. As a result, the introducing or correspondent broker dealer will file FOCUS 2A quarterly. The general securities broker dealer is required to file more frequently and to submit more detailed financial information. . Here is a breakdown of when the FOCUS reports are filed.

• FOCUS Part I is a summary of key financial ratios and numbers that is filed monthly within 10 business days after the end of the month by broker dealers that carry customer accounts.
• FOCUS Part II is a balance sheet, income statement, and net capital computation that is filed quarterly. Broker dealers that clear or carry customer accounts must file Part II within 17 business days from the end of each calendar quarter.
• FOCUS Part II-A is a less comprehensive version than Part II that is filed quarterly. Broker dealers that do not carry or clear customer accounts must only file FOCUS Part II-A within 17 business days after the end of each calendar quarter.

A variable life insurance contract is both an insurance policy and a security because of the way the insurance company invests the cash reserves. A variable life policy is a fixed-premium plan that offers the contract holder a minimum death benefit. The holder of a variable life insurance policy may choose how the cash reserves are invested. A variable life policy typically offers stocks, bonds, mutual funds, and other portfolios as investment options. Although the performance of these investments may tend to outperform more conservative alternatives, the cash value of the policy is not guaranteed. The cash and securities held by the insurance company are invested in the insurance company’s separate account and are kept segregated from the insurance company’s general account. The separate account is required to register as either an open-end investment or as a UIT under The Investment Company Act of 1940. Representatives who sell these policies must have both a securities license and an insurance license. The insured is covered from the date of issuance to the date of death as long as the premiums are paid.

A variable universal life policy gives the policyholder the ability to determine when premiums are paid and to decide how large those payments are. The net premium is invested in the insurance company’s separate account, and the policy’s cash value and variable death benefit are determined by the investment experience of the separate account. A variable universal life insurance policy will remain in effect as long as there is enough cash value in the policy to support the cost of insurance. A variable universal life insurance policy may have a minimum guaranteed death benefit, but it does not have to. A representative who sells variable universal life policies must have both insurance and securities licenses.

Most of us have seen the commercials on TV. A happy couple in their 60s talking about how they have a life insurance policy they no longer need. In these situations the owner of a life insurance policy may elect to sell his or her interest in the policy to a third party in exchange for a lump sum payment during the insured’s lifetime. The sale of the life insurance policy is known as a life settlement.

If a policyholder is suffering from a terminal illness and has a life expectancy of 2 years or less, the individual may enter into a contract known as viatical settlement. The sale of a variable life insurance policy is considered to be the sale of a security and is regulated by both FINRA and the SEC. The buyer of the policy agrees to make all future premium payments and will be entitled to receive the payment of the death benefit upon the death of the insured.

The market for life insurance policies is illiquid, and pricing of policies can vary greatly. FINRA requires any firm that assists in the selling of client policies obtain multiple bids for the policy to ensure that the client receives a fair price. The firm may not enter into any arrangement that would require the firm to sell all or substantially all of its client life insurance policies to any one buyer. FINRA requires agents assisting in the sale of life settlements, as well as the supervisors of the agents, to receive training relating to life settlements. FINRA further requires that the training be documented for each agent and supervisor.

First lets start with defining what volatility is. Volatility is the speed at which the price of an investment changes over time. Independent agencies and third parties often publish bond mutual fund volatility ratings. The purpose of these ratings is to provide information to investors about the sensitivity of the net asset value of a bond mutual fund to a change in interest rates and economic conditions. The volatility rating will be based on a review of the debt instruments owned by the mutual fund. A review of the credit quality, the fund’s performance and risk will also be used to evaluate the portfolio. Specific risks such as interest rate, prepayment and currency risks will all be taken into consideration. When registered persons or the member distribute bond mutual fund ratings as part of its retail communication the following must be disclosed:

• The name of the entity providing rating
• A statement that the rating does not identify or describe volatility as a risk rating
• The most current rating
• Information that at a minimum is current to the most recent quarter’s end
• A link to a website or toll free number providing rating information, methodologies and criteria
• A narrative description containing a statement that there is no standard method for assigning ratings
• The type of risks measured by the rating and time frame i.e. short or long term
• A statement regarding any compensation received for issuing the rating
• A statement that there is no guarantee that the fund will continue to have same rating or performance

If the above disclosures and requirements are not satisfied, the member may not distribute retail communications containing bond volatility ratings.

A broker dealer who includes investment company rankings in its retail communication may only provide ranking information created by a ranking entity, investment company or investment company affiliate. A ranking entity is any entity that is independent from the investment company and who in the normal course of business, provides general information about investment companies to the public. The member using the ranking must include a headline or prominent disclosure stating:

• The fund category (i.e. growth, income etc)
• The number of funds or fund families in the category
• The name of the ranking entity
• If the investment company or affiliate created the category or subcategory of funds included in the ranking
• The length of time measured from the starting date through the ending date
• The ranking criteria (i.e. total return, risk adjusted return)

All communications must include a statement that past performance is no guarantee of future results. Additionally, the communication must disclose whether or not the ranking includes the impact of front end sales loads. If rankings are provided for multiple share classes (A, B or C shares) representing ownership in the same portfolio, a prominent disclosure must be included detailing the different expense structures. All retail communication must be based on the rankings for the most recent quarter’s end. If these rankings are not available, the member may use the most recent rankings available providing that doing so would not be misleading. If the rankings are based on a symbol system such as “star rankings” a detailed explanation as to the meaning of such rankings must be disclosed. Rankings that are based on total return must be based on a time period of at least 1 year.

Rankings for funds that have been in existence for a substantial period of time must be based on total return for the fund for 1, 5 and 10 years. If the fund has been in existence for at least 5 years, the total return must be based on 1 and 5 years. If rankings for 5 and 10 years are not or were not published by the ranking entity, the entity must publish rankings for “short, medium and long” term. Retail communication may not include ranking information that is based on a time frame of less than 1 year unless the ranking is based on the fund’s yield.

Every broker dealer is required to ensure that it has backup systems to ensure the firm may continue to operate in the event one or more its offices become inaccessible. FINRA requires member firms to develop and maintain plans and backup facilities to ensure that the firm can meet its obligations to its customers and counterparties in the event that its main facilities are damaged, destroyed,or are inaccessible.

The plan must provide for alternative means of communication between the firm, its employees, customers, and regulators, as well as a data backup. The plan must provide for data backup in both hard copy and electronic format. All mission critical functions including financial and operational systems and regulatory reporting must be addressed in the plan.The plan must be approved and reviewed annually by a senior member of the firm’s management team and provide plans to ensure that customers have access to their funds. The plan must be provided to FINRA upon request. Should the firm’s business materially change, the business continuity plan should be updated promptly to reflect the change in the member’s business. The plan must identify two members of senior management as emergency contacts, one of whom must be a registered principal with the firm. Should one of the contact people change, FINRA must be notified within 30 days.

Customers of the firm must be advised of the business continuity plan at the time the account is open and in writing upon request. The plan must also be posted on the firm’s website. Small firms with one office should provide a contact number to the clearing firm. Each member firm is required to evaluate its potential vulnerabilities as well as any areas of weakness that may arise from its relationships with other firms and service providers. The A firm's business continuity plan must adequately address each of these issues. A significant business disruption event may require the firm to go out of business temporarily or permanently and customers must be informed of this fact. The firm must inform customers how they will have access to their assets in such an event.

The Securities and Exchange Act of 1934 dictates that broker dealers maintain certain minimum levels of net capital. In order to obtain the required funds firms will often borrow the money from outside sources. A subordinated loan is used by broker dealers to borrow the needed capital. Satisfactory subordination agreements are instruments that allow an individual to loan cash or securities to a broker dealer in return for interest paid to the lender (this is debt for the broker dealer).

Subordinated lenders are not considered to be customers of the broker dealer and are not provided SIPC coverage in the event of the broker dealer’s failure. Under SEC Rule 17a-11, a violation is deemed to occur if the principal amount of satisfactory subordination agreements exceeds 70% of the broker dealer’s debt plus equity total for a period in excess of 90 days. This means that subordinated debt can be considered part of the broker dealer’s net capital, but only if it is through a satisfactory subordination agreement. In order for the loan to be satisfactory, it must meet the following requirements:

• The agreement must be in writing.
• The agreement must be for a specific dollar amount, even if securities are pledged.
• The agreement must subordinate any right of the lender to receive payment to the claims of all present and future creditors of the broker dealer.
• Proceeds of the loan may be used by the broker dealer for any general business purpose.
• The agreement must have a maturity of at least 1 year.
• The agreement may not be subject to cancellation by either party.

The special reserve account is all about protecting the customers’ assets. The Customer Protection Rule ensures that customer funds held by a broker dealer are maintained in safe areas of the business related to servicing its customers or are deposited in a special reserve bank account. The broker dealer must make the following monthly computation to determine the amount required to be on deposit in its special reserve bank account for the exclusive benefit of its customers:

(credit items − debit items) × 105% = the amount to be deposited in the special reserve account If the broker dealer computes weekly rather than monthly, only 100% of the credit excess must be deposited in the reserve account. A broker dealer must compute weekly if at any time its aggregate indebtedness exceeds 800% of its net capital or if its aggregate funds owed to customers exceeds $1 million. The deposit must be made by 10AM 2 business days after the calculation has been made.

The bank holding the special reserve account must acknowledge in writing that the account is the exclusive property of the customers of the broker dealer. As such the bank is not allowed to use those funds to meet the obligations of the broker dealer and the funds may not be used to secure a loan for the firm. If the amount of money customers owe the firm exceeds the sum owed to customers no deposit is required to be made into the separate account.

This is definitely something you want to know as it appears on many real series exams. Broker dealers who meet the $25,000 Capital requirement are allowed to conduct mutual fund business on a wire basis. This allows the firm to accept customer funds and transmit them to the investment company for the purchase of mutual fund shares. Conducting mutual fund business in this way is far superior to the old subscription based model. Customers who purchase mutual fund shares on a subscription basis must fill out a subscription form and forward it to the mutual fund company with a check

Broker dealers who exclusively conduct mutual fund business on a subscription basis are subject to a minimum net capital of $5,000. These types of firms are known as “nickel BDs” Here is the important test point for your exam. Broker dealers who are subject to the $25,000 requirement are allowed to accept a customer’s stock certificate ( ie IBM, Amazon, Apple) and sell the shares for the customer, so long as the proceeds are immediately transmitted to the mutual fund to purchase shares.

The difference between a branch and an OSJ is significant. An office of supervisory jurisdiction or OSJ is empowered to engage in any business activity the member firm is authorized to perform. This includes market making, investment banking and approval of retail communications. A member firm must inform FINRA which offices it has identified as being an office of supervisory jurisdiction (OSJ). An OSJ is any office that conducts one or more of the following activities at that location:

• Has custody of customer funds or securities.
• Has final approval for retail communications.
• Has final approval of customer accounts.
• Reviews and approves customer orders.
• Executes orders or makes markets in securities.
• Forms or structures offerings.
• Supervises employees at other branch offices.

At least one resident principal must manage the OSJ. The resident principal must enforce the policies and procedures of the firm, review all customer activity, and inspect the branch offices within his or her jurisdiction. Each OSJ should have one resident onsite principal who is assigned to the office and who maintains a consistent physical presence at the office. FINRA’s guidelines assume that each principal will have supervisory reasonability for only one OSJ. However, if a member’s business requires it to assign the supervisory responsibilities for more than one OSJ to a principal, the member must document the supervisory arrangement in its written supervisory procedures manual. FINRA would not be required to approve the arrangement but the member should give special consideration to the experience level of the principal, the geographic location of the offices, the number of representatives and if the principal is a producing agent. An office that solely has final approval over the issuance of research reports need not be classified as an OSJ so long as it does not engage in the activities of an OSJ detailed above.

A branch office is any location that is identified to the public as being a place where the member conducts business but does not engage in any of the activities that would require it to be considered an OSJ. Branch offices are inspected by an OSJ. A branch office may operate without a resident principal. A registered representative may act as the branch manager. The supervisory responsibility is with the OSJ.

Understanding the difference between a market maker and an ECN is critically important. Each plays an important role in the NASDAQ market. However, their roles and responsibilities are extremely different. Because there are no DMMs for the NASDAQ markets, bids and offers are displayed by broker dealers known as market makers. A market maker is a firm that is required to display a two-sided market. A two-sided market consists of a simultaneous bid and offer for the security quoted through the Nasdaq workstation.The market maker must be willing to buy the security at the bid price, which is displayed, as well as be willing to sell the security at the offering price, which also is displayed. These are known as firm quotes. There is no centralized location for the Nasdaq market; it is simply a network of computers that connects broker dealers throughout the world. Market makers purchase the security at the bid price and sell the security at the offering price. Their profit is the difference between the bid and the offer, which is known as the spread. Rule changes and new trading systems known as electronic communication networks, or ECNs, have narrowed the spreads on stocks significantly in recent years. Firms that act as market makers must continuously display two-sided quotes during normal business hours. Firms may remain open for extended hours trading but are not required to display quotes after the close of the market at 4:00 p.m. EST. During extended hours trading the market has greater volatility, lower liquidity, and fewer market participants than trading during the regular session. As a result, there are wider spreads and the risk of poor executions.

Electronic communication networks / ECNs are subscriber networks whose role is to match and pair off orders routed to them by broker dealers and institutions. When the ECN has an order imbalance it is allowed to display and execute third-party orders in the NASDAQ market center ECNs are widely used by both broker dealers and institutional investors to display and execute orders. ECN quotes are included in the Nasdaq quote system, but the ECN is not required to maintain a two-sided market like a market maker, and ECNs do not take positions in the security. ECNs may:

• Display 1 sided quotes.
• Enter and accept directed and nondirected orders.
• Accept automatic executions.
• Send orders for automatic execution through the NMCES

The key series 57 test points to remember are

1. Market makers must display a continuous 2 sided market. ECNs are allowed to display a bid or offer only based on customer interest.
2. Market makers may not pull their quotes. ECNS may enter and exit the market as needed.
3. Market makers take on risk and trade in a principal capacity. ECNs never take positions or risk in the security and only act as an agent.

This information will definitely be tested on your series 57 exam.

The alternative display facility or ADF was created in order to provide broker dealers with an opportunity to quote securities in a venue other than the NASDAQ. It was developed many years ago before we had countless market centers to ensure that the NASDAQ was not deemed to be a monopoly. FINRA operates the Alternative Display Facility (ADF) from 8:00 a.m. to 6:30 p.m. EST. The ADF allows market makers and unlinked ECN participants to enter and match quotes and to report trades. The quotes entered in the ADF will not appear in the NMCES. However, if the quote entered in the ADF would improve the inside market, the quote will be displayed as part of the inside market. The ADF does not provide execution capabilities. All ADF participants are required to provide direct or indirect electronic access to their quotes. Direct electronic access will allow other market participants to execute an order electronically against the firm’s quote. Indirect electronic access will allow another market participant to execute an order against the firm’s quote through the firm’s broker dealer customer. Both direct and indirect electronic access requires:

• No voice communication.
• Equivalent speed, reliability, and availability as offered to participants’ customers.
• Equivalent costs as offered to participants’ customers.
• A two-second turnaround for accepting or declining an order.
• A three-second or less turnaround for communication between market participants.

Each ADF participant must certify that it has the ability to display automated quotations during times of peak volume. Each participant is also required to display a marketable quote on each side of the market at least once every 30 days in order to meet certification standards. A firm that is unable to meet the certification standards or who experiences three unexcused outages over 5 consecutive business days will be suspended from quoting all securities in the ADF for 20 business days.

The first thing to keep in mind is that a market maker never has to file form 211 when requesting to quote a NASDAQ stock. An approved market maker who wishes to quote a NASDAQ stock will simply electronically request permission to quote the stock and will receive same day approval to enter their initial quote. If a firm wants to quote an inactive unlisted OTC stock, FINRA wants to know why. SEC Rule 15C2-11 (as amended) sets the standards for non listed companies to develop a public market and for broker dealers to publish quotations for the securities. SEC 15c2-11 requires issues to be current when reporting and disclosing financial and other information. The OTC Markets Group acts as a qualified interdealer quotation service (IDQS) and monitors issuers compliance on an ongoing basis to ensure that issuers are current with their disclosures. A broker dealer wishing to quote an OTC security will be able to rely on the current information designation made by the IDQS in lieu of submitting Form 211 with FINRA. In order for an issuer to maintain its designation as being current, SEC reporting issuers must continuously make timely filings of all reports. Companies listed on the OTCQX, OTCQB and PINK Current are subject to this rule. If companies fail to meet this continuing reporting requirement, the security will be deemed ineligible for public quotes. During market hours quotes for these ineligible securities will be shown as zero (0). However, last sale data for the stock will be available at the end of the day. If the security is deemed to be inactive The issue must work with the broker dealer to file form 211 with FINRA. Rule 15c2-11 permits additional time (180 days) for Exchange Act reporting companies to continue to be eligible for public broker-dealer quotes. Accordingly, companies that make their annual or quarterly reports publicly available (via EDGAR) within 180 days of the end of the reporting period will still be eligible for broker-dealer proprietary quotes, but will be designated as “Limited Information”. Companies who have no information available may be traded on either the OTC Expert market or be forced into the Gray market. The OTC Expert market is where broker dealers may publish unsolicited quotes based on customer limit orders to obtain the best possible execution for the customer. Quotes in the Expert Market are restricted from public view. The Gray market is not an electronic market. The stock of issuers whose securities have been delisted or who are no information companies will be traded over the phone between broker dealers. The Gray market lacks the price discovery made available in electronic markets. Investors should be extremely cautious when considering purchasing securities in either the Expert or Gray market.

Market makers who take on risk in liquid securities base the mark up on the inside market for that security. Meaning the firm’s inventory cost for the security is irrelevant. For example, Let’s assume the market for a stock is: $25 bid and offered $25.20. A market maker who accumulated the stock over a number of days has an average cost of $22. If the firm receives a customer market order to buy the stock, it would base the mark up on the best offer of $25.20. The fact that the firm owns the stock at $22 per share is not considered. Nor would it matter if the firm had an average cost of $28 per share. Some small OTC securities do not have active and competitive markets because of lack of national interest in the company. As a result, the market for these securities can be dominated or controlled by one market maker. Market makers who dominate or control the market for a security must base the markup charged to the customer on their contemporaneous cost, not on the inside market for the security. All markups will be based on the price the market maker paid for the stock when it was purchased for their inventory account. On your exam if the question notes that the firm is responsible for 70 percent of the volume in the stock, this is letting you know that the firm in question is dominating the market. As a result the firm must base the mark up on their inventory cost.

When broker dealers act as underwriters and as market makers there are inherent conflicts of interest. Regulation M Rule 103 was designed specifically to address these situations. Rule 103 regulates the activity of market makers participating in a distribution. Market makers that are participating in a distribution may only act as passive market makers during the restricted period. Passive market makers may not enter a bid for their own account or buy the security at a price that exceeds the highest bid entered by an independent party. If the highest independent bid entered by a nonparticipant drops below the bid of the passive market maker, the passive market maker may remain as the highest bid until it purchases an amount equal to the lesser of its volume restriction or 2 times the minimum quote size for the security. Once this volume restriction is reached, the passive market maker must lower its bid to a price no higher than the current independent bid. If there are no independent market makers, passive market making will not be allowed. The syndicate manager must apply for passive market making status on behalf of all syndicate members by filing part of the Underwriting Activity Form no later than one business day prior to the first full trading day of the restricted period.

If a broker dealer accepts customer limit orders it is required to protect the order and may not trade for its own account at prices that would satisfy the customer’s limit order. The order protection rule is also known as the Manning rule. The Manning rule states that a firm may not compete with a customer’s limit order by executing an order for its own account at a price that would satisfy the customer’s limit. If the firm executes an order for its own account at a price that would satisfy the customer’s limit order, the firm must execute the customer’s order at the same price and for the same number of shares within 60 seconds.Broker dealers that route orders to ECNs or other firms to be displayed must still protect the customer’s limit order and are not relieved of their obligations under the Manning Rule. If the market-making desk is holding a customer’s limit order that is subject to the Manning Rule, no trading desk anywhere within the firm may knowingly execute a proprietary order that would compete with the customer’s order. If the firm has sufficient barriers between its trading desks and the other desk does not have knowledge of the customer’s order, the other desks are not bound by the Manning Rule.

This is definitely a testable question on the Series 57 exam. The timely reporting of transactions is critical for market integrity. All transactions are required to be reported as soon as practicable, but not later than 10 seconds after execution . If a transaction is executed and later cancelled under FINRA trade reporting rules the firm is required to report the transaction promptly. The trader is then required to use the ACT trade scan to cancel the transaction. The trade cancellation report should be made on the same day as the trade was reported provided the trade reporting facility is still open. This rule is in effect for transactions executed during normal business hours as well as for those trades executed during extended hours trading.

A discretionary range order gives the trader the ability to execute a customer’s limit order within an acceptable range of prices. Discretionary range orders provide flexibility to the trader to adjust the order to current market conditions. Providing a range of acceptable limit prices rather than 1 firm fixed limit price increases the chances that the customer’s order will be executed. It is important to remember that a customer’s limit order may never be executed at an inferior price. For example If a customer placed an order to sell 5,000 shares of TRY at $42, the firm would not be able to execute that order at a price less than the stated limit price. This is true even if the trader feels that doing so would be in the best interest of the client. A discretionary range order would provide the trader with the ability to execute the order within a range of prices which are inferior to the desired limit price. If in our example the customer who wants to sell the TRY at $42 provided the trader with discretionary trading range of 25 cents, the trader would be allowed to execute the order at any price of $41.75 or higher. The trader may enter the discretionary range order as a limit order. It will be displayed at the limit price of $42. When entering the order in the NASDAQ system, the trader will append the discretionary range of 25 cents to the order. If a contra bid shows up within the range of acceptable prices the NASDAQ system will execute the order. Using our example, if a bid of $41.80 appeared in the market place the order would be executed at that price.

The operation of the CATS system is definitely an area you want to have down cold. CATS plays a vital role in market surveillance and it is heavily tested on the series 57 exam. In order to ensure that customer orders are transmitted to the marketplace in a timely manner, FINRA developed the Consolidated Audit Trail system (CATS). CATS tracks an order through each stage of its life, from receipt to execution or cancellation. The CATS system has replaced the Order Audit Trail or OATS system previously used to track customer order information. The CATS system is often still referred to as OATS in the industry and may appear as OATS on your exam. Each firm is required to synchronize clocks used for electronic order events to within 50 milliseconds of the National Institute of Standardized Time’s atomic clock. These clocks must display and record military time in hours, minutes, seconds and milliseconds. Each clock used solely for manual order events may be synchronized to a tolerance within 1 second of the NIST clock. Each member may record and submit manual order events and allocation reports to the Central Repository in increments of 1 second. Firms are only requested to collect and submit data in nanoseconds if the firm collects the data. Firms are required to submit daily electronic CATS reports to FINRA’s Central Repository. The business day for CATS is 4:150:00:01 p.m. to 4:15 p.m. the following business day. CATS reports must be made by 8 a.m. on T+1 on the business day following the trade date. For trades executed on Friday, CATS reports may be submitted on Saturday but must be submitted by 8 a.m. Monday morning. Daily CATS reports must be made for each order and include the following information:

• Customer name, account number, date of birth, address and tax ID.
• Date and time of receipt.
• Order ID.
• Terms of the order (i.e. buy, sell, long, short, security, price, shares, account type and handling instructions).
• If the order was received manually or electronically.
• If the order was routed manually or electronically
• Where the order was routed for execution.
• Any modifications to the order, including the date and time of any modifications.
• Execution information, including partial executions, price, date, time, and capacity in which the firm acted in the trade.

The NASDAQ and the OTC markets have multiple venues for executing orders. Each of these require trades to be reported using the proper “input screen". These are user interfaces. It will help you to think of the TRF, ORF and TRACS as nothing more complicated than the order screen you use when placing an order online. The vast majority of transactions will be reported using the Trade Reporting Facility or TRF. The FINRA/Nasdaq Trade Reporting Facility (TRF) is a trade comparison service operated on the ACT platform. It has been designed to greatly reduce questionable trades and trades that one party does not know (DKs). The TRF facilitates the reporting and clearing of trades in Nasdaq and the NYSE listed stocks executed off the floor in the third market. Trades executed on the exchanges do not get reported using the TRF and are NOT reported to the ACT system.

The order reporting facility (ORF) is used to report trades in OTC MKT, OTC PINK and trades in restricted stock under Rule 144A to the NSCC. The “O” in the ORF is a great way to remember the ORF is used for OTC non nasdaq transactions.

The Trade Reporting and Comparison Service (TRACS) collects trade information for market participants who use the ADF. FINRA established TRACS to assist in the reporting of trades for ADF market participants who are not eligible to use the Nasdaq Market Center Trade Reporting Service or ACT. ADF market participants who are also market makers may choose to report trades executed through the ADF either through ACT or the TRACS systems. The TRACS system works in much the same way as ACT. However, the TRACS system will allow ADF market participants to report a three-party trade to assist in the reporting of riskless principal trades. The TRACS system reports trades to the Depository Trust Clearing Corporation (DTCC) and reports the trade to the appropriate securities information processor for public dissemination. FINRA may terminate the TRACS service upon notice to members who fail to abide by the rules of FINRA or the TRACS service.

 When an agent terminates employment with the current broker-dealer, the firm completes and files Form U5. When that is finished, the agent and the new broker-dealer complete and file Form U4. Therefore, the answer to an exam question is that the agent and both broker-dealers must/will notify the Administrator of the change of association.

Some individuals and small firms solicit new business on behalf of an investment adviser. The regulators call such persons solicitors. To use a solicitor, the adviser must be registered; there can be no outstanding order suspending, limiting, or barring the solicitor’s activities; and there must be a written agreement between the solicitor and the adviser. Also, the following conditions must be met:

• The agreement between the adviser and the solicitor must describe the solicitation activities and the compensation arrangement.
• The solicitor must provide the client with the adviser’s disclosure brochure and a separate solicitor disclosure document.
• The adviser must receive a signed acknowledgment from the client that he/she received both the
• RIA’s and the solicitor’s disclosure documents

The adviser must obtain a signed acknowledgment from the client that both disclosure brochures were received. Also, if the solicitor were some shady character, the adviser would not be able to stand back shrugging off responsibility to the regulators. The adviser is expected to do due diligence on the solicitors they use, and if an adviser knew the individual was a convicted felon and hired the solicitor anyway, the adviser would face regulatory action.

Is the solicitor required to be registered? Not by the SEC and not by all the state securities Administrators. The important point is that the adviser must be registered, must oversee the solicitor, and the solicitor cannot be someone ineligible for registration because of criminal or regulatory events.

Most states call a “solicitor” an “investment adviser representative” and make him—or them—register as such. But not all states feel that way.

Before issuing a punitive order to deny, suspend, or revoke an application or registration, the Administrator must provide prior notice, written findings of fact/conclusions of law, and an opportunity for a hearing. The Administrator can take two specific actions without first giving notice and an opportunity for a hearing. The cease & desist order can be issued without prior notice, because sometimes the thing that someone is doing or is planning to do is so outrageous the State needs to stop it immediately. Also, the Administrator can, “summarily suspend a registration pending final determination” of the matter. That means until the hearing has been held and the decision has been reached, the license is “summarily suspended.” Some states refer to a summary suspension as a “show-cause order.”

Broker dealers have an affirmative obligation to obtain the best possible prices for clients. When customers are buying stock broker dealers must execute the customer’s order at the best ( lowest ) offer price available at the time. Alternatively, when customers are selling stock, the firm must execute the customer’s order at the best  ( highest ) bid price available at the time. Provided the prices available meet any limit prices on the customer’s order. It is a violation of industry standards to execute a customer’s order at any price deemed to be inferior to the best price. The inside market for a stock consists of the Highest Bid and Lowest Offer displayed by any firm or in any market.. A broker dealer may never place a third party in between the customer and the best market. This is known as Interpositioning. The placing of another broker dealer in between the customer and the best marke.is prohibited unless it can be demonstrated that the customer received a better price because of it.. Here is an example of interpositioning.

A customer gives Broker an order to buy 3,000 shares of ABCD when the stock is quoted $3.75 X $4.25. Instead of buying the stock for their customer Broker A sends the order to Broker B who buys the stock at $4.10, Broker B then sells the stock to Broker A at $.4.15 and Broker A then sells the stock to the client at $4.25 plus a mark up. As a result both Broker A and B made money and the customer paid more than he / she should for the stock.

Bond yields can be a sticking point for many SIE candidates. Understanding the inverse relationship between price and yield is only the first step to mastering this content. Knowing how the nominal yield, current yield, yield to maturity and in some cases how yield to call relate to one another are essential. The bond see saw is a time tested way to ensure you can handle these questions on your SIE Exam. Practice drawing it out for each possible scenario. This will make these questions visual and in most cases simple. All you have to do is look at the drawing and you will be able to quickly answer the questions on your actual SIE exam. Create the seesaw with bonds at a discount, when purchasing bonds at par and when bonds are purchased at a premium and you will be in good shape. It is important to note that the nominal yield never changes. It is printed in ink on the bond certificate . Your current yield is a relationship between the annual interest payments and the price the investor pays for the bond. Once the investor purchases the bond he /she has locked in their current yield The formula is always Annual Income / Current Market Price. An investor’s yield to maturity is the overall return for purchasing the bond; it takes into account the Annual interest payments with the assumption that they are reinvested at the same rate ( not spent by the owner of the bond) and any gain or loss at maturity. For bonds purchased at a discount the investor will have a gain. For a bond purchased at a premium the investor will  have a loss. Don’t worry you will not have to calculate the yield to maturity. If a bond is callable the yield to call will be the highest yield for a bond purchased at a discount and the lowest for a bond purchased at a premium.

Both front running and trading ahead are violations. Both are based on trading using advanced knowledge and the violations are often confused as a result. Front running is the entering of an order for the account of an agent or firm prior to the entering of a large customer order. For example, let's say that a representative received an order from an institutional investor to purchase 500,000 shares of DEF. Prior to entering the order to purchase the large amount of stock, the representative enters an order to purchase 1,000 shares of DEF. for themselves.. After purchasing the share for their own account the representative enters the order to buy 500,000 shares of DEF for the institutional customer. This large order drives the stock price up and the rep sells their shares at a profit.

Trading ahead is the entering of an order for a security based on the prior knowledge of a soon to be released research report. Research reports can have a substantial impact on the price of the stock covered in the report. This is particularly true when the analyst has a large following. It is not uncommon for the price of a stock to move up or down by 10 percent or more on the day the report is released. Questions on the exam often provide scenarios where a rep walks into an elevator and overhears a conversation between two analysts about a report they are going to release with a price target on a stock significantly higher than its current market price. The rep then returns to his or her desk and buys the stock for clients and themselves.. This is a classic example of trading ahead.

The level of interest rates are determined by a number of factors. Including:

• The level of economic activity.
• The supply and demand for capital
• The level of risk perceived to be in the market.

The money supply is controlled by the Federal Reserve Board largely through open market operations. Open market operations consist of the FRB buying and selling Treasury and mortgage backed securities in the secondary market. When the Fed buys securities it increases the money supply and lowers rates. This has a stimulating effect on the economy. When the FRB is a net seller of securities it is removing money from the banking system and interest rates will increase as a result. The discount rate is the interest rate that the Federal Reserve Board charges member banks on loans made directly by the FRB. The Federal Funds rate on the other hand is the rate banks charge each other for short term loans. These loans are typically overnight or for short periods of time. The Federal funds rate is NOT controlled by the Federal; Reserve Board.  The actual rate is determined by the marketplace. The Fed does set a range or target for what it thinks the fed funds rate should be. However, the borrowing and lending banks ultimately determine the rate.

Accumulation units and annuity units both  represent an investor’s ownership in the separate account. However, the units are owned during different phases of the annuity contract. An accumulation unit represents the investor’s proportionate ownership in the separate account’s portfolio during the accumulation or deferred stage of the contract. The value of the accumulation unit will fluctuate as the value of the securities in the separate account’s portfolio changes. As the investor makes contributions to the account or as distributions are reinvested, the number of accumulation units will vary. An investor will only own accumulation units during the accumulation stage, when money is being paid into the contract or when receipt of payments is being deferred by the investor, such as with a single-payment deferred annuity. When an investor changes from the pay-in or deferred stage of the contract to the payout phase, the investor is said to have annuitized the contract. At this point, the investor trades in the accumulation units for annuity units.

The number of annuity units is fixed and represents the investor’s proportional ownership of the separate accounts portfolio during the payout phase. The number of annuity units that the investor receives upon annuitizing a contract is based on the payout option selected, the annuitant’s age and sex, the value of the account, and the assumed interest rate.

A lot of people get tripped up on this very point. The difference between the 5 and 10 percent rule is an important difference. The goal of diversification is to reduce risk by spreading investments over many different holdings. Mutual funds are designed to help investors achieve diversifications through a single investment in the fund. Mutual funds that market themselves as diversified funds must adhere to the 75-5-10 rule.  the requirements are as follows:

• 75%: Seventy-five percent of the fund’s assets must be invested in securities of other issuers. Cash and cash equivalents are counted as part of the 75 percent. A cash equivalent may be a Treasury bill or a money market instrument.
• 5%: The investment company may not invest more than 5 percent of its assets in any one company.
• 10%: The investment company may not own more than 10 percent of any company’s outstanding voting stock.

Let's look at an example to help you understand this concept better:
XYZ fund markets itself as a diversified mutual fund. It has $10,000,000,000 in net assets. The fund’s investment adviser thinks that the ABC Company would be a great company to acquire for $300,000,000. Because XYZ markets itself as a diversified mutual fund, it would not be allowed to purchase the company, even though the price of $300,000,000 would be less than 5 percent of the fund’s assets. The investment company must meet both the diversification requirements of 5 percent of assets and 10 percent of ownership in order to continue to market itself as a diversified mutual fund.

This can be a bit confusing for test takers. While mutual funds and UITs are both types of investment companies and both are registered under the Investment Company Act of 1940 a UIT is NOT a mutual fund. A Unit Investment Trust is a non managed pooled investment. A unit investment trust (UIT) will invest either in a fixed portfolio of securities or a nonfixed portfolio of securities. A fixed UIT will traditionally invest in a large block of government or municipal debt. The bonds will be held until maturity, and the proceeds will be distributed to investors in the UIT. Once the proceeds have been distributed to the investors, the UIT will have achieved its objective and will cease to exist. A nonfixed UIT will purchase mutual fund shares in order to reach a stated objective. A nonfixed UIT is also known as a contractual plan. Both types of UITs are organized as a trust and operate as a holding company for the portfolio. UITs are not actively managed, and they do not have a board of directors or investment advisers. Both types of UITs issue units or shares of beneficial interest to investors, which represent an undivided interest in the underlying portfolio of securities. UITs must maintain a secondary market in the units or shares to offer some liquidity to investors.

Every transaction in the market consists of 2 parties: a buyer and a seller. No one would be able to buy a stock, bond or option if another party was not willing to sell it to them. The purchaser of the put is absolutely bearish and is betting that the stock price is going to fall. The put buyer pays the premium to acquire the right to sell the stock at the strike price. The premium is paid to the seller of the put contract. In exchange for the premium, the seller takes on an obligation to purchase the stock. Because the seller is now obligated to purchase the stock, the seller is considered to be bullish on the price of that stock. If the seller was bearish and thought the stock price was likely to decline they would not want to buy the stock and would not sell a put. Commit this to memory, the right to sell is bearish and an obligation to buy is bullish.

Most Bonds are designed to provide investors with regular interest payments and are most suitable for investors who have an income investment objective. Matching the particular type of bond to the investor’s profile is the key to answering the questions correctly. In the question there will be keys that help you identify which bond is the most appropriate and therefore correct choice. Key factors include such things as are they looking for maximum income or safety of principal. If they are seeking maximum income corporate bonds are going to be the best choice. Investors who are seeking safety of principal should be placed in the highest rated bond choice in the question. Treasury securities are often the correct choice here. Keep in that shorter term investments carry less interest rate risk. For the most risk adverse investors a money market fund may be the correct choice. There is no market risk and the money market fund will provide some level of income. Treasury bills are not the correct choice for investors seeing income. Remember that Treasury bills are issued at a discount and mature at the par value. Municipal bonds are best for investors who have an income objective but who do not want to incur additional tax obligations. Investors in higher tax brackets benefit the most from investments in municipal bonds. Investors who are in lower tax brackets will be better off investing in corporate bonds of equal quality.

Corporations declare forward and reverse stock splits for very different reasons. When the price of a stock increases to the point where the price makes it too high for many retail investors to purchase a round lot ( typically 100 shares) corporations will often declare a forward stock split. The impact of the forward stock split reduces the market price of the stock making it more attractive to individual investors. For example, let's assume XYZ is tracking in the market at $100 per share and the company declares a  2 for 1 split. As a result of the split XYZ will now be priced at $50 per share. Making it more attractive to individual investors. An investor who owned 100 shares of XYZ before the split value at $100 per share would now own 200 shares of XYZ valued at $50 each. The value of their holdings would not change. Their ownership would be valued at $10,000 before and after the split. To calculate the ownership take the number of shares and multiply it by the split as a fraction 2/1 and you multiply the share price by the reciprocal of the split as a fraction ½. If they are going to test you on an uneven split it will probably be a  3:2 split. Reverse splits on the other hand are effected to increase the price of a stock to make the stock more attractive to institutional investors. Many institutions do not want to purchase shares of stock trading below $5 or $10 per share. In these cases the reverse stock split reduces the number of shares and increases the market price of the stock For example, If ABC was trading in the market at $4 per share and ABC declared a 1 for 10 reverse split ABC would now be trading in the market at $40 per share. An investor who owned 1,000 shares at $4 per share before the split would now own 100 shares at $40 each. The value of the investor’s holdings remained unchained. Their ownership is $4,000 before and after the split.