Principal Transaction

An adviser sells a security from its own inventory to a client without prior consent. This violates:

1. A.The custody rule onlyThe custody rule governs holding client cash and securities and the safeguards that attach to it. Selling from the firm's own inventory is a principal transaction, a conflict-of-interest problem, and it triggers the disclosure and consent requirement whether or not the adviser ever has custody.
2. B.Only a soft guidelinePrincipal transaction disclosure and consent are enforceable requirements, not best-practice suggestions. Treating the rule as advisory is exactly the mistake that turns an ordinary trade into an enforcement action.
3. C.The principal-transaction consent requirementCorrect - consent/disclosure needed for principal trades.
4. D.NothingThis assumes that a fair price cures the conflict. It does not: the client is entitled to know the adviser is on the other side of the trade and to consent before it settles, because that knowledge is what lets the client judge the adviser's motive.

Why: Principal transactions require disclosure and client consent before completion.

Which statement best defines a riskless principal transaction?

1. A.A trade guaranteed against loss by the clearing corporation for the customerNo trade is guaranteed against loss for a customer, and guaranteeing a customer against loss is prohibited conduct.
2. B.An agency trade in which the firm never touches the securitiesThe firm does take the securities into inventory, however briefly, which makes it a principal.
3. C.A principal trade in which the firm offsets the customer trade in the market firstCorrect. The firm buys or sells in the market to fill the known customer order, then completes the trade from inventory with no market risk.
4. D.A trade in which the firm charges no compensation at allRiskless describes the absence of market exposure, not the absence of compensation. A markup or markdown still applies.

Why: In a riskless principal trade the firm receives a customer order, buys or sells the security in the market to fill it, and then completes the trade with the customer from inventory. Because the offsetting trade is already done, the firm holds no market risk.

A principal transaction, where the adviser trades from its own account with a client, requires:

1. A.Approval from FINRAFINRA has no authority over investment advisers, and no regulator signs off on individual trades in any event. The consent that must be obtained comes from the client, transaction by transaction.
2. B.Client consent and disclosure before completionCorrect - consent and disclosure are required.
3. C.Only after-the-fact noticeNotice on the confirmation is better than silence, which makes this the closest wrong answer. It still comes too late: consent must be obtained before the transaction is completed, because a client informed afterward has lost the only chance to say no.
4. D.No disclosure at allWhen the adviser is on the other side of the trade, its interest in the price is directly opposed to the client's. That is precisely the situation the disclosure and consent requirement exists to address, so silence is never the answer.

Why: Principal transactions require disclosure to and consent from the client before completion.

Halsey Securities sells 400 shares of an over-the-counter equity security to a retail customer out of the firm's own inventory. Under SEC Rule 10b-10, the customer's confirmation must disclose:

1. A.Only the number of shares and the execution price, since capacity need not be shown on a principal trade.Wrong. Capacity disclosure is one of the core requirements of the confirmation rule, and principal trades are exactly where it matters most.
2. B.The identity of the person or firm on the other side of the transaction.Wrong. Contra-party identity is not a required confirmation item, though a customer may request it for an agency trade.
3. C.That the firm acted as principal for its own account, and whether the firm is a market maker in that security.Correct. Capacity must always be disclosed, and for a principal trade in an equity security the market-maker status must be stated as well.
4. D.The firm's original acquisition cost for the shares, in every principal transaction.Wrong. Cost or markup disclosure is required in defined circumstances such as riskless principal trades, not on every principal ticket.

Why: Rule 10b-10 requires the confirmation to state the capacity in which the firm acted - agent or principal - because the customer's costs and the firm's conflicts differ sharply between the two. When the firm acts as principal in an equity security, the confirmation must additionally disclose whether the firm is a MARKET MAKER in that security, since a market maker's inventory position gives it an interest in the trade the customer should know about. The confirmation also carries the trade and settlement dates, quantity, price, and the firm's remuneration where required.