Safekeeping

A custodian is best defined as an entity that:

1. A.maintains the issuer shareholder registerWrong. That is the transfer agent, which works for the issuer rather than for the investor.
2. B.selects investments for a client portfolioWrong. That is an investment adviser or portfolio manager. Custody and discretion are deliberately separated.
3. C.holds cash and securities for safekeeping on behalf of an account ownerCorrect. Safekeeping and the associated settlement and recordkeeping are the custodian job, without investment discretion.
4. D.guarantees the value of the assets it holdsWrong. Custodians safeguard assets from loss or misuse. They never guarantee market value.

Why: A custodian holds cash and securities for safekeeping on behalf of an account owner and handles settlement and recordkeeping for those assets. It does not decide what to buy or sell.

Cordray Financial's WSPs were last updated when the firm only cleared equities. The firm has since begun clearing municipal bonds, but nobody revised the procedures to address municipal settlement or safekeeping. An examiner cites the firm. What is the defect?

1. A.The firm failed to segregate duties within the municipal desk.Wrong. Nothing in the facts describes one person performing incompatible functions; the problem is that no procedure exists for the new activity at all.
2. B.The firm failed to hold its annual compliance meeting.Wrong. The annual meeting is a separate Rule 3110(a)(7) obligation, and nothing in the facts suggests it was skipped.
3. C.The WSPs were not updated to address a new line of business.Correct. Procedures that no longer reflect the firm's actual activities fail the reasonably-designed standard regardless of how the municipal trades were actually handled.
4. D.The firm's business continuity plan did not address municipal bond settlement.Wrong. A business continuity plan addresses disruption response, not day-to-day procedural coverage of a new product line; that is what WSPs are for.

Why: FINRA Rule 3110(b) requires WSPs to be reasonably designed to achieve compliance with applicable rules, which means they must be updated whenever the firm's business changes in a way that creates new compliance obligations. Adding a new product line without revising the WSPs to address it leaves the new activity effectively unsupervised on paper, even if staff happen to handle it correctly in practice. The violation is the failure to update, not any particular trade going wrong. The fix is a documented WSP review triggered by the new business line, not a one-time acknowledgment that municipal settlement is different.

A firm pledges fully paid customer securities together with securities the firm owns to obtain a bank loan for the firm's own use. This practice is:

1. A.ChurningWrong. No trading in customer accounts is described. The violation is one of custody.
2. B.Front runningWrong. Front running concerns trading ahead of orders, not the use of customer property as collateral.
3. C.Permissible, because the loan proceeds benefit the firm's customers indirectlyWrong. Indirect benefit is not a defense; the customers' own property is now exposed to the firm's creditors.
4. D.Commingling of customer and firm assetsCorrect. Fully paid customer securities must be segregated, not pledged for the firm's borrowing.

Why: This is commingling, mixing customer assets with firm assets. Fully paid customer securities must be segregated and held in safekeeping, and hypothecating them for the firm's benefit exposes customer property to the firm's creditors.

Ashgrove Securities holds two blocks of customer stock it may not use. One block sits in safekeeping; the other is fully paid stock moved to segregation out of a margin account. What distinguishes how the operations department must identify the two blocks on its records?

1. A.Both blocks must be tracked certificate by certificate to the individual customer who owns them.Wrong. Segregation asks only that the aggregate customer-owned quantity be held free of firm use, with no certificate-level identity required.
2. B.Segregated stock must be registered in the name of the customer, while safekept stock stays in street name.Wrong. Registration is a separate question from custody status, and set-aside positions are routinely held in street name at the depository.
3. C.Safekeeping ties specific certificates to the depositing customer; segregation holds an aggregate quantity in fungible bulk.Correct. Certificate-level identity is precisely what separates the two custody states.
4. D.The firm may finance a debit balance with segregated stock, while safekept stock is entirely off limits.Wrong. Stock that remains available to finance a debit is by definition not the stock the rule requires to be set aside.

Why: Safekeeping and segregation both put customer stock beyond the reach of the firm, but they do it at different levels of specificity. Stock accepted for safekeeping is identified to the depositing customer certificate by certificate, so the firm can hand back the same certificates it took in. Segregation is a bulk concept: the firm determines the quantity of each issue that belongs to customers and cannot be used, and holds that quantity apart in fungible form without tying particular certificates to particular customers. Had the customer asked the firm to hold the specific certificates she deposited, the position would be safekeeping and the certificate-level record would be required.