Tag Archives: FINRA

Form U4 and Form U5 | Information About the Uniform Registration Forms for Broker-Dealers and Investment Advisors

Purpose of the Forms and Discussion of Recently Approved Changes & Requirements

The Financial Industry Regulatory Authority (FINRA), is the largest independent regulator for all securities firms doing business in the United States, and is the entity designated as the filing depository by the U.S. Securities and Exchange Commission for purposes of the Investment Advisers Act of 1940.  There are currently six different Uniform Registration Forms that are used to file information with FINRA. The Form U4 (Uniform Application for Broker-Dealer Registration) and the Form U5 (Uniform Termination Notice for Security Industry Registration) are used by broker-dealers to register, and terminate the registrations of, associated persons with self-regulatory organizations (SROs), and jurisdictions.

Representatives of broker-dealers and investment advisers use Form U4 to register with the states and with self-regulatory organizations (e.g., FINRA). Forms are filed electronically by their employing firms using the Central Registration Depository (Web CRD or IARD). Broker-dealer agents and investment adviser representatives have an obligation to update previously filed Forms U4 with any new information required to be disclosed. FINRA makes information filed on Form U4 publicly available through its BrokerCheck program.

Broker-dealers and investment advisers use Form U5 to terminate a representative’s registration in a particular jurisdiction or with a particular self-regulatory organization. Firms terminating the registration of an associated person must respond to a series of disclosure questions. Firms also have the obligation to update previously filed Forms U5 if they become aware of new disclosure information.

As discussed above, Form U4 and Form U5 filings (initial applications. termination notices, and amendments) will generally be made electronically through Web CRD or IARD. However, some individuals may need to file the form on paper, including: agents of issuers, certain persons filing with stock exchanges, and certain investment adviser representatives. In addition, NASD Rule 1013 requires the submission of certain paper Forms U4 along with an initial membership application.

The SEC recently approved amendments to Forms U4 and U5 that were proposed by FINRA that call for significant changes to disclosure questions on the Forms, including the addition of questions about certain regulatory actions. The new  amendments to the Forms include:

  • New regulatory action questions that will enable FINRA and other regulators to identify more readily persons subject to a particular category of “statutory disqualification” under the federal securities laws and the FINRA By-Laws. Among the items that would cause a person to become subject to a statutory disqualification are “willful” violations of the federal securities laws, the Commodity Exchange Act, or the rules of the Municipal Securities Rulemaking Board. Under the proposed rule changes, both Forms U4 and U5 would be amended to add questions requiring disclosure of findings of “willful” violations.
  • New questions that require firms to report allegations of sales practice violations made against a registered person in an arbitration or litigation in which the registered person is not a named party. Under the new amendment, reporting would be required if the registered person was either named in or could reasonably be identified from the body of the arbitration claim or civil litigation as a registered person who was involved in one or more of the alleged sales practice violations.
  • An increase in the monetary threshold for reporting settlements of customer complaints, arbitrations or litigation from $10,000 to $15,000.
  • The clarification that the date to be provided by a firm in the “date of termination” field is the “date the firm terminated the individual’s association with the firm in a capacity for which registration is required.” Under the new amendment, a firm would be permitted to change the date of and reason for termination, but would be required to state a reason for the change.

The revised Forms were implemented in Web CRD on May 18, 2009. The effective date for most of these changes  is May 18, 2009 (the “release date”). The effective date for the new regulatory action disclosure questions will be 180 days from the release date, or November 14, 2009.

Key Items Regarding the Forms Changes:

Invalidation of Pending Form Filings Upon Web CRD System Shutdown:

  • Implementation of the revised “form versions” will cause all pending (in-process) Form U4 and U5 filings that are not submitted to Web CRD prior to system shutdown on Friday, May 15, 2009, to become invalidated (i.e., converted to a read-only mode). Firm users that still need to submit the information on those invalidated filings will need to recreate the filings using the new forms.

Form U4 Amendments Required:

  • All registered persons are required to answer new regulatory action disclosure summary questions the next time they file a Form U4 amendment or no later than 180 days following the release date.

Copies of the revised Forms and instructions are available here.

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Please contact us if you have any questions or would like to start a hedge fund.  Other related hedge fund law articles include:

FINRA to Regulate Member’s Retail Forex Activities

Comments on Proposed Retail Forex Rules Sought

The Finanacial Industry Regulatory Authority (FINRA) requested comments on a proposed rule to limit the leverage available to retail investors trading in the off-exchange foreign currency (forex) markets.  The proposed rule would be applicable to FINRA member firms and would limit leverage in forex transactions to 1.5 to 1.  The proposed leverage limits are significantly lower than the leverage limits currently offered in the industry (which can reach up to 100 to 1 or higher).  The leverage limitation would not be applicable to eligible contract participants.  The FINRA proposal is the latest step in a series of regulatory tightening measures which have been instituted with the goal of protecting retail investors from the risks of the forex markets (for more information please see New Forex Registration Requirements).  Comments on the proposal are due February 20, 2009.  Continue reading

FINRA New Issue Rule 5130 (Text of the Rule)

As we announced earlier today, the NASD New Issue Rule 2790 has changed and is now FINRA Rule 5130.  The text of the New Issue rule is below and can also be found on the FINRA website here.  With regard to hedge funds, this rule is most important with regard to who will be deemed a “restricted person” and thus generally ineligible to recieve a full allocation of any gains attributable to new issues (commonly known as initial public offerings or IPOs).  The full text of the rule follows.  Continue reading

Hedge Fund “New Issue” Rule Changes

Minor Modifications to “New Issues” Rule Approved; New FINRA Rule 5130

FINRA (formerly the NASD) has been reworking a new rulebook which means that many rules have been modified and renumbered.  At least one important hedge fund rule has been renumbered.  The “new issue” rule, which affects hedge funds and other members of the securities community, has been slightly modified and is now known as FINRA Rule 5130 (formerly Rule 2790). Hedge fund managers should discuss with their attorneys whether their hedge fund offering documents need to be updated to reflect this change.  Continue reading

Hedge Fund Law – Summary of Hedge Fund Laws and Regulations

he following is a summary of the major laws which affect the hedge fund industry.  If you have any questions on how these laws impact hedge funds in general or your specific situation, please contact us.

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Securities Act of 1933 – the 1933 Act was enacted on May 27, 1933 as a reaction to the market crash of 1929. The overarching purpose of the act was to require that all “securities” be registered with the government (at the time the FTC). The Act provides some exemptions from this general requirement; for hedge fund managers, the most important exemption from registration is found in Section 4(2) which provides that securities will not need to be registered is they are sold in a transaction which does not involving any public offering. Continue reading

SEC releases statement on protection of customer assets

One of the major questions right now from both hedge fund investors and hedge fund managers is how safe are their assets.  I will be writing an article detailing the answer to this question over the next couple of days.

In the interim, the SEC has released a statement and so has FINRA.  I have posted a brief portion of the FINRA statement which can be found here.  I have also posted the entire SEC statement which can be found here.

FINRA Statement

In virtually all cases, when a brokerage firm ceases to operate, customer assets are safe and typically are transferred in an orderly fashion to another registered brokerage firm. Multiple layers of protection safeguard investor assets. For example, registered brokerage firms must keep their customers’ securities and cash segregated from their own so that, even if a firm fails, its customers’ assets will be safe. Brokerage firms are also required to meet minimum net capital requirements to reduce the likelihood of insolvency, and to be members of the Securities Investor Protection Corp (SIPC), which insures customer securities accounts up to $500,000. SIPC is used in those rare cases of firm failure where customer assets are missing because of theft or fraud. In other words, SIPC is the last course of action in the unlikely event that the other customer protections have failed.

SEC Statement

Statement of SEC Division of Trading and Markets Regarding the Protection of Customer Assets
FOR IMMEDIATE RELEASE
2008-216

Washington, D.C., Sept. 20, 2008 — The Securities and Exchange Commission’s Division of Trading and Markets today issued the following statement:

In recent days, Securities and Exchange Commission staff have received a number of questions from investors regarding the protection of their assets held by broker-dealers.

Customers of U.S. registered broker-dealers benefit from the extensive protections provided by the Commission rules, including the Customer Protection Rule, as well as protection by the Securities Investor Protection Corporation (SIPC). The Commission’s Customer Protection Rule requires a broker-dealer to segregate customer cash and securities from a broker-dealer’s own proprietary assets. More specifically, the rule requires that a broker-dealer keep customer cash and fully paid securities free of lien and in a safe location.

Any person who has deposited funds or securities in a securities account at a broker-dealer is a “customer” under the Customer Protection Rule. Securities customers of U.S. broker-dealers are not permitted to opt out of the protections afforded by the Customer Protection Rule. There is a technical exception for affiliates of the broker-dealer, but this exception would not affect the protections generally extended to a customer’s funds and securities deposited at the broker-dealer.

In addition to the Commission’s rules that protect securities customers, SIPC also protects securities customers up to $500,000 per customer, including a maximum of $100,000 for cash claims. To determine if your broker-dealer is a member of SIPC, or to learn more about the SIPC protections, you can check the SIPC website at www.sipc.org.

What licenses do you need to start or manage a hedge fund?

Question: What licenses do you need to start or manage a hedge fund?

Answer: This is a question that comes up quite often. Many people wonder whether they need a series 7 license or the series 65 license or the series 3 to manage a hedge fund. First, a potential hedge fund manager does not need to have a series 7 license in order to manager a hedge fund. The series 7 license is the general securities representative licese which allows an individual to be a representative (broker) of a FINRA registered member firm (brokerage firm or broker-dealer). The series 7 allows a representative to take and place trades for a customer. It is also a prerequisite for many of the other FINRA exams (such as the series 24). Because the hedge fund in not regulated as a broker, a hedge fund manager does not need to have a series 7 license (assuming that the manager is also concurrently acting as a broker-dealer representative).

Second, a start up hedge fund manager may need to have a series 65 license in order to become registered as an investment adviser. There are two potential ways a hedge fund manager would be required to register as an investment adviser – under the federal rules (the Investment Advisers Act of 1940) or under the various state rules (commonly referred to as the state blue sky laws). If a manager is required to register with the SEC under the Advisers Act* then, for federal purposes, the manager will not need to have taken the Series 65. However, the Advisers Act allows states to impose certain requirements on all federally registered investment advisers with a place of business in their state. Generally the states will require all federally registered investment advisers to “notice file” in their state which entails paying a fee to the state. The state can also require that all investment adviser representatives have the series 65 license. This means that anyone who talks to clients/investors or makes any trading decisions or analysis will need to have this license. The definition of investment adviser representative basically encompasses every employee or owner of the investment adviser other than secretary type employees. If you are a federally registered investment adviser you should discuss whether members of your team need to be licensed as representatives at the state level.

If you are not a federally registered investment adviser (generally all managers with less than 30 million of assets under management) then you will need to determine whether your management firm needs to be registered as an investment adviser at the state level. Many states require investment advisers with a place of business** in the state to register. Some popular states that require investment adviser registration are California, Texas, Washington and Colorado. However, there are many states which have exemptions from the registration requirements. Some popular states that have exemptions (through regulation or special order) from investment adviser registration for hedge fund managers are New York, Connecticut, Florida and Georgia. Again, you should speak with your legal counsel or compliance professional to determine whether your hedge fund management firm will need to be licensed as an investment adviser in the state.

Finally, if the hedge fund trades futures or commodities then the manager may need to be registered as a commodity pool operator with the National Futures Association. In order to register as a commodity pool operator at least one person at the management company will need to take the Series 3 exam. For more information on the Series 3 exam and this part of the registration process please read how to register as a CPO or CTA.

* Many potential hedge fund managers are confused with whether a management company will need to be registered as an investment adviser with the SEC. The answer is that in most cases a hedge fund manager will not have to be registered as an investment adviser with the SEC because of an exemption provision within the investment advisers act. Section 203(b)(3) of the Advisers Act specifically exempts from the registration provisions “any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients and who neither holds himself out generally to the public as an investment adviser nor acts as an investment adviser …” The term “client” in the hedge fund context means a “corporation, general partnership, limited partnership, limited liability company, trust …, or other legal organization … to which you provide investment advice based on its investment objectives rather than the individual investment objectives of its shareholders, partners, limited partners, members, or beneficiaries…”

This means that as long as a hedge fund manager will not need to count the investors in the hedge fund as his “client” and that the hedge fund itself is the only “client.” You will probably recall that a couple of years ago the SEC proposed a change to the rules under the Advisers Act that required a manager to count all of the investors in the hedge fund as clients. Under the proposed rule hedge fund managers would have been required register with the SEC (if they had at least $30 million under management), but Phillip Goldstein successfully challenged the SEC in court. His successful challenge to the rule change allows hedge fund managers to escape SEC regulation.

** “Place of business” of an investment adviser means: (1) An office at which the investment adviser regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and (2) Any other location that is held out to the general public as a location at which the investment adviser provides investment advisory services, solicits, meets with, or otherwise communicates with clients.

The Series 65 Exam

If you are a hedge fund manager in certain states (California and Texas are two prominent examples) then your management firm will need to be registered as an investment adviser with your state’s Securities Commission. In all states, the prerequisite for such registration is that the firm have at least one investment adviser representative who has passed certain qualifying exams (the Series 65 exam or the Series 7 and Series 66) or have certain designations (CFA, CFP, etc).

This post intends to give you an overview of the Series 65 exam and some thoughts on taking and passing this exam.

The Series 65 basics

What: a three-hour (maximum) 140 question computer based exam which focuses on the following topic areas: economics and analysis; investment vehicles; investment recommendations and strategies; and legal and regulatory guidelines, including prohibition on unethical business practices. The exam features 10 ungraded questions (which can appear anywhere within the test) and an examinee needs to correctly answer 89 of 130 graded questions (70%).

Where: you will take the exam at either a Pearson-Vue or Prometric testing station.

When: you will sign up to take the exam at a time of your choosing on either the Pearson or Prometric website. It is recommended you schedule the exam at least a week prior to the date you plan to take it.

Why: it is required for a person to become registered as an investment adviser representative.

How to sign up

You will typically register for the Series 65 by submitting a Form U-4 through the IARD system or by submitting a Form U-10 online. Your law firm or your compliance consultant can help steer you through this process. Also feel free to contact us if you have any questions.

The cost to take the exam is $120. There may also be some state and IARD fees if you are signing up for the exam through the Form U-4 process.

How to study for the exam

I recommend to all of my clients that they put a pretty good effort into studying. I have seen a good portion of very smart hedge fund managers fail the exam on the first try. The central reason, in my opinion, is lack of a diligent study program. While the Series 65 is not a college chemistry exam, it still covers a lot of information which is probably new to the manager. Accordingly, I recommend that a manager set aside at least 40 hours to prepare for the exam. During the preparation phase, I recommend the following:

Get a study guide and read the guide from front to back. I read my study guide from front to back while I actively created notecards as I read each chapter. Doing so takes much longer, but afterward I was able to keep the notecards in my pocket and review them whenever I had free time, which kept the material fresh in my mind.

I used the Kaplan study guide. I am partial to the Kaplan study guides and have exclusively used these guide when studying for the various securities exams I have taken – I have passed the Series 3, Series 7, Series 24, Series 65 and Series 66 exams. The major frustration with the Kaplan guide is that it contained many errors. However, I think that Kaplan does the best job of preparing practice questions which will be very similar (if not exactly the same) to what you are likely to see on the exam. There are some other study guides out there like the “Pass the 65,” however, I have not found a guide which presents the information in a simple, matter-of-fact way like the Kaplan materials.

Other study options include various multi-media and internet applications. Kaplan also has a full-day class you can take from an instructor.

Take two to three practice exams. I took two Kaplan practice exams. After taking each exam, I examined the answer to every question, including the ones I correctly answered. This review process really helped me to solidify my understanding of the material. [Note: you may need to take more than two practice exams to feel comfortable with your knowledge base. If this is the case, I highly recommend taking more practice exams.]

Get a good night of rest the night before the exam. I always scheduled my exams in the morning. This way I can get the exam out of the way early and I do not need to be anxious during the day. I try to get a good night’s sleep the night before. At this point, it is not going to help your exam performance to stay up into the morning trying to cram.

Day of exam

Make sure you wake up early enough to be awake and alert. You should eat a proper breakfast. Allow extra time to get to the testing site. Pearson and Prometric have different rules about when you are supposed to show up at the testing site. A good rule of thumb is 45 minutes prior to your testing time. When you get to the testing site, you will sign in and the proctor will give you the rules of the testing site. Be ready to take everything out of your pockets and to take your jacket off (it is advisable to dress in layers as the testing rooms are often kept at very cool temperatures). You will likely be nervous before the test – I took the opportunity after signing in and before the test time to review a few of the more important note cards before I put them in my provided locker. This kept my mind busy, calmed my nerves, and gave me a little extra bit of confidence that I could answer the questions on the exam.

The exam

The exam is a computer-based exam so the first five minutes or so you’ll be given an on-line demonstration of the manner in which to answer questions and mark them for review. After this demonstration, the exam will start. The first ten to fifteen questions will generally be easier than the questions which come in the middle of the exam – don’t get too complacent. The middle of the exam will drag on and during this time there were many questions which I was not sure about and there were a lot of questions where I had to give a best guess. At about 2/3 of the way through the exam, I thought that I was going to fail for sure. Be aware of this, it happened to me in almost every single FINRA exam which I took.

Because the exam is so long – 180 minutes – you may need to use the restroom during the middle. If this is the case don’t hesitate to take some time for a break. During these breaks I would take some time to grab a drink of water and take a few deep breaths. When you get back, complete the last half or third of the exam in a methodical manner. If you encounter a question which you do not have a clue about how to answer, either guess and move on or guess and mark the question for review. Do not spend an inordinate amount of time trying to come to the correct answer – there are enough questions which you will know the answers to and it is most important that you get to those questions without being flustered. Remember also that the final 15 to 20 questions are generally going to be easier.

When you have answered all of the questions you will have the option to go back over your answers and to change any of your previous answers. It is recommended that you do not make any changes unless you are positive that your new answer is correct. Once you have certified that you are satisfied with your present answers the computer will ask you to confirm that you wish to proceed. When you confirm, the computer will begin to process your answers. During this minute or so your heart will race as adrenaline pumps through you. The screen will then tell you if you have passed or not.

If you don’t pass

Some people will not pass this exam – I have spent plenty of time on the phone talking to managers who almost passed. If you don’t pass it is not the end of the world. The major drawback of not passing the exam is that you will have to wait 30 days to take the exam again. If time is of the essence, this drawback could be the difference between an on-time hedge fund launch and the dreaded delay. As such, I always stress to the client that it is much better to be overprepared than underprepared. You will thank yourself for those extra few hours when you have passed the exam. If you do not pass the exam on the second try, you will need to wait 60 days to take the exam again.

***UPDATE FOR MAY 2010***

As many of you know, the Series 65 exam changed in 2010 and it is now much more difficult to pass.  I have heard more stories from people this year about not passing than I did last year.  Also a concern is that the study guides are not spending enough time on the new emphasis in the exam.  For instance, one person I just spoke with mentioned that there were many more questions on trusts and pensions than were covered in the study guides.  As always I recommend you get an up to date study guide and take at least two practice exams before taking the actual exam.