Study guide
This final chapter combines the remainder of Section 3 (prohibited activities, AML, communications with the public — 3.2.3, 3.3.1) with Section 4 (Overview of the Regulatory Framework), covering registration, continuing education, and reportable events. Though the smallest domain by question count, it is heavily tested on judgment-based scenario questions about ethics, disclosure, and regulatory conduct — an area where careful reading of the fact pattern matters more than raw memorization.
Prohibited Activities: Market Manipulation and Fraud
FINRA and the SEC prohibit a range of manipulative and deceptive practices designed to protect market integrity. Market manipulation includes practices such as painting the tape (a group of colluding traders creating the appearance of active trading through wash trades to attract other investors), matched orders (coordinating buy and sell orders between parties to create a false impression of market activity without a genuine change in beneficial ownership), and pump-and-dump schemes (spreading false or misleading positive information to inflate a security's price before selling at the inflated price). Front running is trading ahead of a customer's known pending order (or ahead of research that is about to be published) using knowledge of its likely market impact — a breach of duty to the customer. Insider trading involves trading securities based on material, nonpublic information in breach of a duty of trust, prohibited under the Securities Exchange Act of 1934 and further addressed by the Insider Trading and Securities Fraud Enforcement Act of 1988, which increases penalties and extends liability to controlling persons who fail to supervise. Churning is excessive trading in a customer's account, inconsistent with the customer's objectives, primarily to generate commissions for the representative — a suitability and fraud violation. Selling away refers to a registered representative conducting securities business away from the sponsoring broker-dealer without the firm's knowledge and approval, itself a violation regardless of whether the underlying investment is legitimate.
Communications with the Public
FINRA Rule 2210 governs broker-dealer communications with the public, categorizing them as correspondence (communications to 25 or fewer retail investors within 30 days), retail communications (any written communication to more than 25 retail investors within 30 days), and institutional communications (distributed solely to institutional investors). Certain retail communications and template materials require principal pre-approval before use, and many types must be filed with FINRA's Advertising Regulation Department within required timeframes, particularly for new member firms or certain product types (e.g., options communications, some mutual fund and variable product materials). All communications must be fair, balanced, and not misleading, avoiding exaggerated, unwarranted, or promissory claims, and must not omit material facts necessary to make statements not misleading given the context. Testimonials require disclosure that the experience is not necessarily indicative of future performance and, if compensation was involved, disclosure of that fact. Performance projections and predictions of investment results are generally prohibited outside of specific, permitted circumstances. Recordkeeping requirements obligate firms to retain copies of all communications with the public along with supporting documentation for a specified retention period, supporting later regulatory examination.
Anti-Money Laundering (AML)
The Bank Secrecy Act (BSA) and the USA PATRIOT Act require broker-dealers to maintain a written AML compliance program designed to detect and report suspicious activity that might indicate money laundering (disguising the origins of illegally obtained funds) or terrorist financing. Every member firm must designate an AML compliance officer, provide ongoing employee training, conduct independent testing of the program, and implement a Customer Identification Program (CIP) to verify the identity of every customer opening an account, typically requiring name, date of birth, address, and identification number (such as SSN or tax ID). Firms must file a Suspicious Activity Report (SAR) with the Financial Crimes Enforcement Network (FinCEN) when a transaction of $5,000 or more appears suspicious, and are prohibited from disclosing to the customer that a SAR has been filed. Currency Transaction Reports (CTRs) must be filed for currency transactions exceeding $10,000. Red flags for potential money laundering include structuring transactions to fall just under reporting thresholds, unusual patterns of activity inconsistent with a customer's stated profile, frequent wire transfers with no apparent business purpose, and reluctance to provide identifying information. Money laundering conceptually occurs in three stages: placement (introducing illicit funds into the financial system), layering (obscuring the funds' origin through complex transactions), and integration (reintroducing the now-'clean' funds into the legitimate economy).
Registration, Qualification, and Continuing Education
Individuals who engage in the securities business of a broker-dealer — soliciting, effecting, or supervising securities transactions — must register as representatives (e.g., under a Series 7 or other appropriate license alongside the SIE) with FINRA and applicable states, while certain support staff performing purely clerical or ministerial functions are generally not required to register. Principals, who supervise the securities activities of the firm and its representatives, must hold an appropriate principal license (such as Series 24) in addition to meeting experience prerequisites. The SIE itself is a prerequisite exam covering foundational knowledge but does not, by itself, qualify a person to engage in securities business or receive transaction-based compensation — a representative-level or principal-level 'top-off' exam and sponsorship by a member firm are also required. FINRA's Continuing Education (CE) program has two components: the Regulatory Element, computer-based training on regulatory, compliance, and ethical topics that registered persons must now complete annually (by December 31 of each year) under FINRA Rule 1240, and the Firm Element, an annual training program each firm must develop and administer covering its own products, services, and any changes in the regulatory environment relevant to its registered persons. A registered person who fails to complete the Regulatory Element becomes 'CE inactive' and may not engage in or be compensated for activities requiring registration; if that inactive status continues for two consecutive years, the registration is administratively terminated and the person generally must retake and pass the appropriate qualification exams to re-register.
Reportable Events and Regulatory Oversight
Registered persons and member firms have ongoing obligations to disclose specified events through the Central Registration Depository (CRD) system via Form U4 (individual registration) and Form U5 (termination of registration). Reportable events on Form U4 include criminal charges or convictions (felonies and certain misdemeanors), civil judicial actions, administrative proceedings by regulators, customer complaints alleging sales practice violations, arbitration claims, terminations for cause, and financial matters such as bankruptcies, liens, and bonding company denials — all of which must be updated promptly (generally within 30 days of the firm learning of the event) and are reflected in the publicly accessible BrokerCheck system. Registered persons must also disclose outside business activities (OBA) — any compensated activity outside the scope of their relationship with the sponsoring firm — to their employing member firm before engaging in them, allowing the firm to assess for conflicts of interest or unauthorized securities activity; firms may approve, limit, or deny such activities. Private securities transactions ('selling away') conducted by a representative outside the scope of their employment must be disclosed to and approved by the firm in writing before participation, whether or not compensation is involved. This reporting and supervisory framework — encompassing FINRA's examination and enforcement authority, state regulators, and the SEC's oversight of FINRA itself — is designed to give the investing public visibility into a registered person's regulatory history and to allow firms to supervise activity that could create conflicts or harm customers.
Key terms
- Churning
- — Excessive trading in a customer's account, inconsistent with objectives, primarily to generate commissions.
- Front running
- — Trading ahead of a customer's pending order or unpublished research using advance knowledge of its market impact.
- Selling away
- — A representative conducting securities business outside the sponsoring firm without its knowledge and approval.
- Suspicious Activity Report (SAR)
- — A confidential report filed with FinCEN for transactions of $5,000 or more that appear suspicious; customers must not be told one was filed.
- Currency Transaction Report (CTR)
- — A report required for currency transactions exceeding $10,000.
- Customer Identification Program (CIP)
- — A firm's required process for verifying a customer's identity when opening an account, part of its AML program.
- Form U4 / Form U5
- — U4 registers an individual with FINRA and discloses reportable events; U5 is filed upon termination of a registered person.
- Regulatory Element / Firm Element
- — The two components of FINRA continuing education: annual regulatory/compliance/ethics training and firm-specific product/service training.
- Outside business activity (OBA)
- — Any compensated activity outside a representative's relationship with their firm, which must be disclosed to the firm before starting.
- Placement, layering, integration
- — The three conceptual stages of money laundering: introducing illicit funds, obscuring their origin, and reintroducing them as clean funds.
Exam tips
- When a scenario describes a rep doing business the firm doesn't know about, the term is selling away regardless of whether the product itself is legitimate — the violation is the lack of firm approval.
- SAR filings are confidential by law — if an answer choice says the firm tells the customer about a SAR, it's automatically wrong.
- Know the two AML thresholds precisely: SAR at $5,000+ suspicious activity, CTR at over $10,000 in currency — these dollar figures are tested directly.
- The SIE alone never qualifies someone for securities business or compensation — a representative-level exam plus firm sponsorship is always still required, a commonly misunderstood point.
- Outside business activities must be disclosed to the firm BEFORE starting them, not after — timing is often the detail that makes an answer choice wrong.
- For communications questions, remember 25-or-fewer retail investors in 30 days = correspondence; more than 25 = retail communication, which often requires principal approval and/or filing.